Let's start with the math:
Allowed Sales - Cost of Goods Sold = Gross Margin
Gross Margin - Operating Costs = Net income or loss
Allowed sales is the amount providers reasonably expect to collect for authorized deliveries of covered products and services to eligible patients based on their existing coverage.
Cost of goods sold (COGS) are the variable costs of the products and services actually sold. When companies purchase these goods for future sale, those items are an asset called inventory. COGS, on the other hand, is a reduction of that inventory when sold to customers; it is the expense directly matched to the allowed sales recognized from the sale. Gross margin, or contribution margin, is the difference between sales and direct costs available to cover fixed operating costs and profit.
For example, say we deliver a supply to a patient that costs us $50 and record revenue of $100 based on the allowable amount under the patient's current insurance policy. The gross margin of this transaction is $50. This represents the ideal scenario, and unfortunately, it is where most budgeting and forecasting stops.
Let's now assume that the supply is non-covered. We cannot get the supply back for resale, so we record a $100 operating cost in the form of bad debt. All other things being equal, we have a $50 loss (the $100 allowed sales price - $50 COGS -$100 bad debt operating cost). To be sure, you always had a loss, it just took months or years to acknowledge it. Multiply that by the thousands of similar transactions and the pending avalanche seems obvious.
My guess is that you already know whether you are making any money. The mystery lies in what to do about it.
Billing Success is Not the Same as Profitability.
Almost universally, profit is used synonymously with billing performance. As such, managers often add more people and ...ahem...operating costs in response to disappointing profits. And while we have seen collection rates improve over the last several years, even a 100% collection rate cannot create profit if the allowed sales are less than the variable COGS and operating costs. Now, faced with reimbursement rates that fundamentally disregard the very simple equations above, providers are in trouble, not because their collection rates are subpar, but because gross margin built into current rates cannot cover the operating costs.
The panic-stricken reaction is to reduce operating expense to the bone without proper respect for the balance of these equations. Cutting the wrong expenses or using finite resources ineffectively actually increases operating expenses via inefficiency. To make profitable decisions, providers must:
- Understand the gross margins and operating costs for each significant payer and product.
- Mitigate, if complete elimination is not possible, those sales that do not adequately contribute to necessary operating expenses (talking about it is not enough).
- Use objective data instead of pleas for fairness to effectively negotiate better rates.