Most Common Mistakes in Financial Budgeting/Forecasting – Part I

In an ever-changing health care environment, the accuracy and effectiveness of financial budgets and forecasts have faced increased scrutiny and questioning from health care entity boards and management teams. As a result, BKD has developed a 3-part series to address the most common mistakes we see in financial budgets and forecasts prepared by health care entities.

In Part I, we outline common mistakes related to the effect of complacency on the budgeting process.

Part II and part III will address mistakes related to the consistency of budget and forecast assumptions and aligning the budget or forecast with the entity’s overall strategic mission.

For anyone who has spent any time in the public accounting world, you are likely familiar with the acronym SALY (same as last year).

Auditors are taught to avoid this acronym when preparing workpapers, as significant changes or other issues often can be glossed over. Likewise, you should avoid the similar pitfall of relying on the previous year’s activity when preparing budgets or forecasts.

Specifically, consider the following:

One-Time Items: Remove any 1-time items from historical financial statements used in the budget/forecast preparation. Examples include electronic health record or other incentive payments, nonrecurring expenses related to major renovations or various other one-time items that are not expected to continue.

Incremental Budgeting: Avoid incremental budgeting, which takes last year’s results and adds an inflation factor. Rather, take into account both known and potential changes to operations. For instance, consider the impact on reimbursement due to expected changes in charge inflation and payor mix, as well as the staffing and non-labor costs required to generate the budgeted/forecasted revenues (Part II of this series will offer further discussion on the consistency of forecast assumptions). Some entities may choose to periodically implement a form of zero-based budgeting, which builds the budget from the ground up rather than simply increasing last year’s budget.

Hockey Stick Effect: Refrain from budgeting based on hope rather than reality. Everyone has witnessed the “hockey stick” budget in one shape or another. Management should be prepared to justify budgeted increases compared to historical results — revenue and profitability bridges work great for board presentations to quickly draw attention to the key changes.

Historical Budget Comparison: Consider your management team’s track record with respect to historical budgeting. If your historical results consistently have exceeded or fallen short of budgeted results, has a previous conservative or aggressive mentality caused inaccurate budgets or forecasts?
Once you have prepared a base working document, be cautious not to fall into the trap of preparing a static annual budget and putting it on the shelf to collect dust. Rather, the annual budget should be adjusted monthly in preparation for board meetings to provide an updated forecast for the fiscal year.

This results in a document that remains useful to the board each month and keeps everyone’s attention on the entity’s goals for the remainder of the year. For example, if the addition of a new major employer shifted your entity’s payor mix and activity levels, adjust the forecast for the remainder of the year to represent a more realistic view.

Finally, while the base budget/forecast should incorporate management’s expected financial position and course of action, board members frequently prefer to see more than one scenario. Consider using your entity’s historical fluctuations and industry benchmarks to quantify the sensitivity of various budget/forecast assumptions.

Sensitive assumptions may include the effect of incremental volumes, proposed reimbursement changes, charge inflation, payor mix, staffing levels or expense inflation. In addition, scenarios may illustrate the impact of potential future capital projects or the addition/removal of services.

We have touched on only a few of the most common mistakes made in financial budgeting/forecasting, to provide a foundation to consider as you enter your next budget/forecast cycle. Keep your eyes open for Part II covering the consistency of budget/forecast assumptions and Part III on the alignment of the budget/forecast with the entity’s overall strategic mission.