Costing System in Hospitals

The growing need of hospitals to have an efficient system to control costs and at the same time maintain quality

Modern day hospitals provide a variety of services to patients under one roof. It is akin to a large service organisation considering the number of personnel involved and the capital-intensive nature of the business be it the civil structures, operation theatres and equipment, diagnostic and therapeutic equipment, resuscitation equipment, gas lines, surgical instruments, consumables, and so on. Moreover, it is a 24×7 operations with people playing a vital role in the well being of the patients in the hospital.

There are various complexities that necessitate the hospital management to put in place robust costing systems. However, traditional hospital managements have not given serious thought to the same. The corporate world has adopted and benefited from good costing systems, since the early 1930’s. The same holds true of modern day corporate hospitals, who believe in providing cost effective services to patients and ensuring patient loyalty to the healthcare provider.

Traditionally, hospitals used bed occupancy as the yardstick of measurement of performance. With the advancements in medical technology, the average length of stay (ALOS) is reducing and hence, bed occupancy is not the main performance measure any longer.

The increased utilisation of costly resources, e.g. equipment in operating theatres, ICUs, Cath-Lab, Pathology Lab etc. in addition to doctors’ times are the key to success in hospitals.


Until a few years ago, it was practically absurd to think of a marketing function within a hospital. That situation is pass with almost every hospital worth its salt employing marketing professionals to attract new corporates. Hospitals also employ loyalty cards and discount health cards to attract and retain customers.

The advent of health insurance companies has also queered the pitch. With the costs of treatment going up and the privatisation of the insurance industry, the hospitals are forced to give quality service at highly competitive prices as the insurance companies will pay only for the services that are desired and will also monitor the services that are rendered closely. This leads to deductibles, co-payments and all claims by hospitals do not get settled hundred percent. There is also a time element involved as costs are incurred upfront and outstanding amount is received only after a couple of months.

It is therefore imperative for hospitals to have a system to control the costs, while at the same time providing high quality service to the patients.

The costing problem

Patients undergoing treatment receive services of varied nature from different departments. The hospital has to recover the expenses of the direct departments as also of the support departments from the patients availing these services.

Nowadays, any composite hospital with latest facilities for advanced medical/surgical procedures in the various areas of treatment will have nearly 50 or more revenue centres and about 10 to 15 supporting service centres. Furthermore, most of the revenue centres, particularly, in-patient wards, will have classification depending on the level of services for different class of patients according to their monetary or other needs. Again, each department, other than wards, undertakes several types of procedures/operations etc.

All these make the list of procedures and classification of services quite large. It is for this reason that ascertaining true costs of various services and fixing of the Schedule of Charges becomes extremely complex. Costing needs to be done after careful analysis of past data, comparative data from other hospitals, study of utilisation of capacities. Costing techniques shall be applied to provide acceptable costs and charges, enabling optimization of capacity utilization, which, in turn, result in better overall revenues and leave adequate funds for growth and development of newer and advanced facilities.

Setting up a costing system

Unlike in other industries, where pricing of products/services is generally uniform except in special cases such as exports, institutional sales etc., in hospitals most of the services rendered are charged at different rates based on class of patients. Besides, a category of patients are given free or semi-free treatment, where the charges are nil or kept very low.

Thus, the final charges or pricing has no direct relevance to ‘costs’ individually. But, the overall revenue expected from the charges recovered from all patients has to cover the total costs incurred, to make the procedure or department self-supporting. This matching of expected revenue and costs can be done only on the basis of exhaustive analysis of past quantitative and financial data. Thus, detailed statistics play an extremely important role in Costing of services and fixing of schedule of charges.

Based on such analysis, discussions with medical personnel of each department, regarding the practical problems and expected quantum of each procedure with class-wise level of patients and detailed budgeting of revenue has to be made. This forms the broad structure for cost allocation to the various cost centers and fixation of individual charges. Keeping in mind the purpose and its importance to the hospital in recovering all expenses incurred, the procedure for cost allocation should be designed so as to obtain accurate and realistic results. We shall not go into the intricacies of these procedures in this article but limit ourselves to the basic steps for the purpose of ascertaining the final costs to obtain the desired results.

Broadly, the steps needed include identifying the various cost centers in the institution and arranging them into revenue producing centers by charging patients for the services and supporting non-revenue producing centers, allocating direct expenses to all centers by analysis of each element of cost, developing cost allocation criteria for allocating costs of supporting cost centers to other supporting cost centers and revenue producing centers. Now, each revenue center has the total direct costs of the center and indirect costs representing the allocated expenses of the supporting centers. The total costs thus arrived at for each of the revenue providing centers is to be appropriately distributed among the various services rendered to the patients by that center. This involves not only finding the nature of the services but also learning the general application of the services to the patients. This should be done in conjunction with the medical personnel and modalities determined for each type of service.

Once the costs are available for each profit and cost center, they can be used for the various purposes identified earlier. Typically, to arrive at the above costs, one needs to setup various monitors across the hospital, which will give the necessary data for computing the costs. Computerisation could significantly simplify the process of data collection and analysis. A good hospital management system software should form the basis for the costing system.

Objectives of a costing system

  • Utilisation of resources
  • Department-wise profitability analysis
  • Fixation of doctors’ honorarium
  • Fixing schedule of charges
  • Monitoring of factors affecting pricing

Whatever be the philosophy of the Management, they need to ensure efficient utilisation of costly resources and they should take informed decisions on pricing. A scientific costing system is a very important tool for managements to fulfill these needs and hence, is imperative for the successful running of a hospital.

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Related Februaury 2011