COST ACCOUNTING IN THE OPERATING ROOM

Managing the financial aspect of the OR is often one of the most difficult tasks for the physician OR director. Most physicians have not had a formal business education, and the language and decision making in OR management can be confusing. It is essential that economic theory as it relates to the OR be understood. Health care is big business with big challenges. In the United States, more than $1 trillion was spent on health care in 1997, or 14% of the U.S. gross domestic product. ^[75] The health care industry employed more than 4 ¼ million people according to the August 2003 Bureau of Labor Statistics. The costs for hospitals to deliver health care have been increasing at 4% to 5% above the inflation rate throughout the 1990s. Clearly, strong financial management within the hospital is essential for success.

The concept of management control in nonprofit organizations has recently become more sophisticated.^[76] Financial management of the OR can be analogous to running a business.^{[77] [78] [79]} An OR can be classified as an expense center or a profit center. If it is classified as an expense center, attempts to improve the financial position of the hospital would be focused on reducing costs in the OR. If, however, the OR is considered a profit center, attention to costs but also revenue is important in decision making. It is reasonable for hospitals to focus on performance of the OR. The OR may represent 40% of the total costs of a hospital, but it is responsible for as much as 70% of the revenue.^[1] As ambulatory health care activity has moved out of the hospital, many hospitals have become primarily tertiary care surgical facilities. Managing costs in the OR and increasing its revenue will result in a facility with strong profitability and the ability to expand its health care delivery.

A basic discussion of cost accounting is necessary to provide the OR director with the terms and methodology to improve decision making in the OR. First, the difference between costs and charges is important to recognize. In the 1970s and 1980s, most hospitals operated on a cost-plus billing theory. An amount of money (profit) was added to the costs for a procedure, and this resulting charge was submitted to and paid by insurers. However, as reimbursements declined, insurers began to contract services for a specific price, regardless of what the hospital's costs were for that service. The ratio of costs to charges varied widely for different services throughout the hospital.^[1] A comparison of the cost-to-charge ratios at Stanford Hospital demonstrated that they varied from 0.29 for anesthesia, 0.50 for laboratory, to 0.92 for the surgery admission unit.^[1] Because of the arbitrary nature of assigning charges to a service, as well as the variable reimbursement, decisions concerning OR management always should use costs and not charges. Costs can also be divided into fixed and variable classifications. Fixed costs (overhead) are costs that do not change over a certain period (i.e., 6 months). In the OR, these costs would represent rent or depreciation of the surgical suite, capital equipment in the OR, salaried or full-time paid employees, and administrative overhead (OR directors, medical records, admitting personnel). Fixed costs are not affected by changing volumes of service in the short term. Fixed costs may decrease over longer periods if OR suites can be closed or the budgeted number of OR staff is reduced. Variable costs will increase or decrease directly with the level of surgical activity. In the OR, variable costs include disposable supplies, sutures, linens, implants, and contracted labor. Operating rooms have a large part of their total costs fixed, often ranging from 56% to 84%.^{[80] [81]} This point is important to understand because short- and intermediate-term changes in cost reduction will apply only to the variable portion of OR costs, which represent a smaller part of the total OR costs. The fixed costs will remain unchanged.

The two methods to account for costs in the OR are either top-down or bottom-up. Top-down accounting uses cost-to-charge ratios to average and estimate the

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Profit for the OR is equal to the revenue minus costs (both fixed and variable). The OR is frequently expected to produce profit to pay for other areas within the hospital (e.g., emergency department) that operate at a loss. However, in assessing changes in surgical activity, the term "contribution margin" is more important. Contribution margin is equal to the revenue minus the variable costs. If the contribution margin is positive, it will be beneficial to the business because it will contribute money to pay down the overall fixed costs of the institution. A listing of these accounting terms is found in Table 86-20 .

Using terms and accounting methods, we can now do a more detailed analysis of OR financial management. Marcario, in a 1999 review of costs, found that the majority of total costs for care of a patient undergoing laparoscopic cholecystectomy occurred in the OR.^[81] The OR (37%), anesthesia (7%), PACU (6%), and OR-related laboratory and pharmacy costs accounted for more than 50% of these total hospital costs. For any OR procedure, most of the OR costs are incurred in the first hour of the case. These costs include room preparation, opening of the bulk of the basic supplies, linens, and use of instruments or implants for the procedure. Subsequent time in the OR may be less expensive and consists primarily of labor costs. Using a detailed analysis, Marcario established that in his institution, the basic costs of an OR, exclusive of procedure-specific needs (such as trocars or implants) was $13.54 per minute.^[81] Of this amount, 62% of the costs were fixed, and only 38% were variable. Cost-savings measures (i.e., changing physician practice) will affect only the variable costs of this expense. Obviously, OR costs are different at each institution, depending on such things as labor and overhead costs. Ambulatory surgical facilities, with reduced overhead, may have overall OR costs 20% less than hospital facilities.

Anesthesia costs, such as machine depreciation, supplies, and drugs, may represent 6% of the total hospital costs for a procedure.^[1] Of these costs, approximately half are fixed and half are variable. If measures are taken to reduce overall anesthesia costs in the OR, only the variable part of

TABLE 86-20 -- Operating room accounting terminology

Charges	The fee listed for an item or procedure based on assumptions of resource consumption
Costs	The actual expenses incurred in delivery of a service
Fixed costs	Overhead. Costs that do not change up or down over a finite period, regardless of the volume of activity
Variable costs	Costs that change directly up or down with changes in volume of activity
Profit	Revenue—costs (both fixed and variable)
Contribution margin	Revenue—variable costs
Capacity	Maximum amount of activity that a facility can deliver without increasing fixed costs

the anesthesia costs is available to be modified. Therefore, only 3% of the total hospital costs are at stake with modifications in anesthesia practice.^[82] This smaller potential amount of cost savings should be considered when decisions are made on cost reduction strategies in the OR.

The PACU tends to be an area with very high fixed costs—up to 67% of the total PACU costs.^[1] For this reason, opportunities for large cost reductions in the PACU by changing practice may be difficult.

The largest variable cost associated with health care in general and the OR in particular is personnel costs.^[83] The unpredictable nature of the surgical volume, as well as late-running cases, may lead to increased labor costs. Because the Fair Labor Standards Act requires overtime wages of 150% of regular wages for hours worked over 40 per week, personnel costs can greatly increase with poorly planned labor use in the OR. Strategies to minimize overtime by using 12-hour shifts, staggering nurse work times, and creating greater scheduling control will help reduce these labor costs. Careful analysis of nursing requirements and the creation of optimal staffing patterns can have a significant impact on OR costs.^{[84] [85] [86] [87]}

Studies have been performed on the contribution margin of individual surgeons to the hospital.^{[41] [88]} These studies have shown that nearly all surgeons have a positive contribution margin, but the difference in amount of contribution margin between surgeons varies greatly, by amounts of over 1000%.^[89] To improve profitability for the OR, efforts to increase the volume of highly profitable surgeons will have the greatest impact. However, before assigning more OR time to these surgeons, several questions must be addressed. Is the surgeon able to increase his volume by 25% if he is given 25% more OR time, or will his utilization decrease with this additional time? Do this surgeon's cases require other hospital resources (ICU beds, specialty nursing) that have limited capacity? If more volume is achieved, does the system have enough overall capacity (OR rooms, nurses, anesthesia coverage) to provide the service and hold fixed costs neutral? If additional volume of cases requires building more infrastructure (new rooms or more OR nurses), the fixed costs will increase and potentially negate the amount of profit anticipated.

In light of these complex business issues surrounding OR management, it is surprising that so little emphasis has been placed on this important piece of administration by hospitals. It has been estimated that less than 10% of ORs have computer systems within each of their operating rooms. Hospital information management is nearly 20 years behind industry in its application of

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