CEO SUMMARY: Reviewing an AP practice’s expenses is vitally important today when payers are cutting reimbursement. In the past, government and private payers paid more for the technical and professional components of anatomic pathology work, but those rates have eroded. While conversations about revenue tend to obscure the need to talk about expenses, effective financial management is not solely about revenue because every dollar cut from spending will increase net income.
THIRD IN A SERIES
PHYSICIANS IN PRIVATE PATHOLOGY GROUPS often complain that they work harder today than they have in the past and yet they get paid less, observed Al Sirmon, a founder (along with Chappy Manning, RN, CPC, CPMA) of Pathology Practice Advisors in Columbia, S.C.
As a consultant to anatomic pathology practices, Sirmon hears this complaint whenever the conversation turns to payment for AP services, in part because it’s mostly true. Payment for common AP codes have declined in recent years. Yet there are strategies anatomic pathologists can employ to ease the financial pain.
“When I consult with AP practices, I emphasize the importance of giving equal attention to both income and expenses,” Sirmon said. “It’s natural to want to spend time talking about ways to increase revenue. That’s because reviewing expenses is not as glamorous as looking at revenue.
“Nonetheless, it’s critically important today, in part because you can also boost profit by reducing expenses,” he commented. “Before 2012, for example, pathologists used to get $60 for the technical component of a CPT 88305, a surgical pathology procedure. That $60 was enough to cover a lab’s costs easily. Then, almost overnight, most payers cut that payment to $30, thus making it imperative to look at cost and ways to reduce expenses.
Cost to Provide Services
“Effective financial management is not solely about the revenue a pathology group generates. It’s also about the group’s cost to provide its services,” observed Sirmon.
“Assume the group admitted a new partner last year by promoting an associate physician to partner,” he noted. “The associate thus went from a lower-paid position to a higher-paying job. That factor alone could explain why pathologists in this group feel as if they work harder and get paid less.
“The expense side of the pathology practice plays a major role in how much income is available for pathologist compensation,” he continued. “Groups should look at all types of expenses that make up the expense section of the income-and-expense statement.
“The income-and-expense statement allows an AP group to compare what it spends for certain services against the revenue generated from those services,” he said. “Doing so allows pathologists to identify which services generate the most profit and which services fail to generate enough revenue to cover their associated costs.”
In the first two articles in this series, Sirmon outlined the steps anatomic pathologists can take to identify potential sources of new revenue. (See, “AP Groups Can Protect Revenue, Pathologist Compensation,” TDR, April 8, and “Improve Your AP Group’s Financial Performance,” TDR, April 29.)
In this installment, he outlined how practices can manage expenses more effectively. “When a pathology practice examines its expenses, it should use a classified income statement,” said Sirmon. “This is a critical step for any group’s financial analysis as every dollar cut from the expense side drops directly to the bottom line and shows up as an increase in net income. It’s not an increase in revenue but it serves the same purpose.”
A classified income statement is usually more condensed than an unclassified income statement, but it is more meaningful than an unclassified income statement that simply lists the expenses alphabetically.
Major Expense Categories
“On a classified-income statement, we classify expenses into the following major categories: cost of goods sold (technical component); selling, general and administrative expense; and physician expenses.
“The cost of goods sold is the cost to produce a slide,” he noted. “This number includes the cost of equipment and stains and any staff who prepare slides for the technical component.
“We also have expenses classified as, selling, general, and administrative (or SG&A),” he continued. “Cost of goods sold and selling, general, and administrative, are those expenses incurred before the group pays its physicians, which is classified as physician expense.
“When preparing a classified-income statement, experience has taught me that one of the most important costs are the salaries and benefits of the technicians,” he said. “Those costs, together with the cost of the stains and the slides, go into the section ‘cost of goods sold.’ In this section, the pathology group collects all costs related to preparing slides.
Buying Slides from Hospital
“Some pathologists work in hospital labs where they don’t own the equipment and they don’t make their own slides,” Sirmon commented. “Instead, they buy those slides from the hospital for their outreach work. We include those costs as purchased services, which is included in the cost-of-goods-sold section on the expense side of the financial reports.
“Often, it’s useful for pathologists who work in hospitals where they buy the slides from the hospital for their outreach work to perform a make-versus-buy analysis,” he noted. “In this exercise, the pathology group compares what it pays for the slides the hospital histology lab produces with the costs the pathology group would incur if it established a free-standing histology lab outside of the hospital and made its slides there.
“Many groups we work with have their own independent labs,” Sirmon commented. “These labs hire their own histotechs, they own the equipment, and prepare the slides themselves.
“Costs incurred on those short histology production lines are high,” he said. “Many AP groups today use IHC stains, some of which are very expensive. In addition, histotechs who prepare those slides are high-priced staff.
Slide Production Costs
“One way to understand the cost of producing a slide is to look at the actual costs from the ground up,” Sirmon added. “What does the blank slide itself cost? What do the stains cost? How much time does it take to prepare a slide?
“Analyzing costs this way is the typical method, but there is a better way,” he suggested. “It is best to look at what the group actually spent to produce slides in a year. Then compute the average cost per slide.
“For example, it doesn’t matter how much stain is used per slide if that inventory of stains sits on a shelf and expires,” Sirmon reasoned. “It’s much better to look at the total cost over the year that the group spent on supplies and labor and compute the average total cost.
“Actual costs will include all stains—even those that were not used and are still in inventory,” he said.
“Also, be aware that often pathology costs in a hospital lab may get blended in with the hospital’s costs to run the clinical lab, or they might be included in the microbiology lab’s costs,” he noted. “Those numbers need to be separated from the AP costs.
Identifying Each Cost
“It’s important to know exactly which costs the group incurs for the work it produces,” noted Sirmon. “We categorize all expenses and total those numbers. Total cost of goods sold and selling general and administrative expenses are subtracted from revenue to give us the income before physician expense. This is the number that the physician-partners will split.
“Once a pathology group has this classified income and expense statement, we recommend that it classify income and expenses into departments,” he continued. “Every AP practice should have at least two departments: one for hospital patients and one for outreach. With those numbers, it’s easy for the pathology group to compare the income to expense by each department.
“A final recommendation is for the pathology group to do a detailed comparison of its hospital income versus its outreach income,” advised Sirmon. “We make this suggestion because a pathology group’s outreach program typically requires the additional payroll costs of sales people and the client service personnel who talk to referring physicians, plus other costs. All of that adds to the expense of doing outreach work, but not when serving inpatients.”
Why Pathology Groups Need to Classify Their Expenses
ONCE AN ANATOMIC PATHOLOGY PRACTICE has categorized all of its expenses, the next step is to match them to their corresponding revenue centers, said Al Sirmon of Pathology Practice Advisors. “Every AP group has three big revenue centers:
1) Histology (88300 through 88309 codes),
2) Special stains (88312 and 88313),
3) IHC stains.
“By matching expenses to income, the AP group can understand the level of profitability of each revenue center, Sirmon explained. “To match expenses to revenue, the group should take the cost of special stains and compare that number to the revenue paid to the group for CPT codes 88312 and 88313 for the year.
“Next, the group does the same for IHC stains,” he added. “These steps are important because one or more of the group’s payers may not pay much for IHC stains. It is also good financial practice for the group to break out its expenses by cases, by blocks, and by other CPT codes.
“Once the group knows its costs to produce each service it delivers, it can either cut those costs, if possible, or ask insurers to cover more of those costs, if necessary,” he said. “If this analysis is never done, the group may never know which services do well—meaning they generate a healthy profit—and which do poorly—meaning this service is losing money or barely breaking even.”