Hidden costs--a real threat.

Operations analysis is an imperative

MORE AND MORE BOARD MEMBERS AND EXECUTIVE DIRECTORS are asking their chief financial officers two penetrating questions: (1) Why are we having to spend a large percentage of our annual donations to cover operating expenses while we're not really helping low-income seniors by offering reduced rates? (2) Should we be spending most of our entry-fee cash collected from unit resales to fund operations expenses?

Perhaps it's time for a pragmatic operations analysis. There are two important benchmarking ratios that can help lay a solid operations-analysis foundation. The operating-expense ratio shows the relationship between your revenues and expenses. It represents total cash operating expenses divided by net revenues. It generally excludes depreciation, interest, and principle payments, and includes a management fee and a modest allocation into a reserve fund for future building improvements. The expenses-per-resident-day index is based solely on operating expenses. It is your total annual operating expenses (as defined above) divided by your total resident population times 365 days.

Always look for two possible problems: either your revenues may be too low or your expenses may be too high. Let's say your operating-expense ratio appears high. By computing your expenses-per-resident-day index, you can usually identify the source of the problem. For example, if your operating expenses per resident day are also high, it is very likely that your primary problem is excessive expenses--not suppressed revenues.

Let's try to isolate the potential operating expense problems on a typical campus. If you have multiple living arrangements (independent living, assisted living, skilled nursing, etc.), compute the previously mentioned ratios for both your consolidated campus operation and for each of your living arrangements as individual cost/profit centers. Once you spot a potentially troubled living-arrangement operation, compute the operating expenses per resident day for each operating department within that isolated cost/profit center (dietary, housekeeping, direct care, administration, etc.)

Finding this analysis difficult? Not surprising, because this is usually where many sponsors and owner/operators hit the wall. Their existing financial-reporting structure does not allow them to isolate individual cost/profit centers, much less have their direct labor (cooks, housekeepers, CNAs) and other costs properly allocated to each department. That's important because each cost center (and each department) has a unique set of generally acceptable benchmarks (see "Operations analysis benchmarks," below). Some sponsors may have serious operations problems, but these flaws are masked by having one large consolidated "black hole of operations" rather than distinct, stand-alone cost/profit centers.

At the lowest level of cost containment, there are three departments that frequently surface as problem areas. They are administration, dietary, and assisted living/direct care. For example, let's look at the direct cost of just one additional direct-care, full-time employee (FTE) on the day and evening shifts. At $10.00 per hour, that's $20,800 per year. Add taxes and fringe benefits of 25 percent and we're now at $26,000. So for a 40-hour week, two-shift coverage, that's $52,000. Add weekend coverage and the total direct cost is $72,800, and if you also provide coverage for typical 20 percent employee downtime, that cost will grow to more than S87,000. On medium-to-large CCRC campuses, I frequently find five or more excess FTEs. It is not unusual to find up to $500,000 per year of potential savings within a large CCRC.

There are two strategic cost-reduction questions: (1) What's reasonable? and (2) When will quality of care really be impaired? Benchmarks shown in the box represent high-quality, successful operations reflecting a majority of operations nationally. Any benchmark must be used with caution, but you can no longer afford to rationallze your expensive operation by simply saying, "we're different." From a strategic and philosophical perspective, sponsors must strike a delicate balance between quality of care and reasonable costs. (See "Today's CCRC dilemma," March 2001 CLTC, page 55.) Today, hitting specific operational performance targets is a critical imperative for every for-profit and not-for-profit sponsor.

It's true that our primary mission is to consistently deliver high standards of care to our residents. But in doing so, we can't let this noble objective mask or be an over-simplified rationale for grossly inefficient operations.

Jim Moore is president of Moore Diversified Services, a Fort Worth, Texas-based national senior housing and health care consulting firm. He is author of Assisted Living 2000 and, most recently, Assisted Living Strategies for Changing Markets.

Operations analysis benchmarks
Benchmarks represent approximately 75% of market experience
Key benchmark          Independent living  Assisted living   Nursing
Expense ratio                .52-57            .63-.70       .85-.93
Expenses PRD 1              $28-$35            $55-$65      $115-$125
Direct care minutes
 per resident/24 hrs.         N/A               45-65        130-170
Total FTEs/
 occupied unit-bed          .30-.40            .45-.55       .70-.85
(1)Per resident-day
SOURCE: MOORE DIVERSIFIED SERVICES INC.