Assessing How Well Hospitals Budget Operating Results by Examining the Relationship Between Budget Variances and Operating Margin

Abstract

There is a near-universal assumption in both practice and literature that greater accuracy and management of the budget improves profitability (Libby & Lindsay, 2010; Umapathy, 1987). Prior to this study, this assumption has gone untested, and we know little about the wisdom of such an assumption.

The results of this study indicate greater accuracy in forecasting and/or tighter management to the budget, or favorably exceeding it, are associated with improved profitability. More specifically, smaller unfavorable budget variances are associated with greater operating margins as are greater favorable budget variances. A single standard deviation reduction in unfavorable revenue and expense are associated with higher operating margins of 5.2% and 6.3%, respectively. An equivalent favorable deviation in revenue and expense are associated with higher operating margins of 3.2% and 2.7%, respectively. Managers can improve hospitals' operating margins by first prioritizing the reduction and/or eliminating unfavorable variances, and second increasing favorable variances.