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Issue: 60 - Dec 16, 2013
Proactive Management of Inflation Challenges
By: Matt S. Nolan
Marsha L. Heinke, CPA, Inc

As the New Year quickly approaches, practice administrators must be attentive to the volatile state of the economy, recognizing how inflation continuously works to erode profit margin. The basic measure of inflation is tracked by the Consumer Price Index (CPI), and the CPI is a useful tool for financial management.

Inflation influences every economic facet of your hospital’s operations. Areas of great significance include facility use, inventory, and employee costs; and fees should reflect these costs of practice operations, as inflation occurs. To counter the effect of ever-rising expenses, practices must protect their profit margin and keep employees adequately paid through timely fee increases.

Let’s use facility rent to showcase practical use of the CPI. Facility rental lease agreements commonly include escalation clauses tied to the change in the CPI. CPI data can be found on the Bureau of Labor Statistics website here: ftp://ftp.bls.gov/pub/special.requests/cpi/cpiai.txt.

An escalation clause might require annual rent adjustment based on the CPI change. If the annual average CPI index for the year ended December 31, 2011 was 224.939 and for the year ended December 31, 2012, was 229.594, then the difference between the two indices is 4.655, which represents the annual change in the CPI for 2012.  Supposing your practice’s lease agreement is tied to CPI, the 4.655 point change would represent a 2.07% increase in 2013 rent over that of 2012 (divide the index change by the previous period’s index).

Furthermore, if your practice is negotiating a new lease agreement with CPI escalation clauses, be aware the lessor may insist on a minimum “floor” that rent will increase if inflation is stagnant. These “floors” may be more prevalent if inflation continues to increase at levels lower than previous years. Where floors exist, ceilings can be placed, too. A maximum rate change in the base rent can prevent large increases at times inflation accelerates. Price points for services should be adjusted to keep up with inflationary factors such as rent and vendor costs. Consider quarterly adjustments to fee schedules using a prospective CPI index. Use the CPI as a guide to increase prices, but don’t rely on it exclusively. Trust both your own market knowledge and inflation indices.

Plan prospectively. Forecast your best estimate of the inflation rate over the coming three to twelve months. Keep an eye on financial publications and blogs for blending multiple “expert” opinions.  The  Federal  Reserve  Bank  of  Philadelphia  has  run  the  Survey  of  Professional Forecasters since                            1990.  This free resource can be found at http://www.philadelphiafed.org/research-and-data/real-time-center/survey-of-professional- forecasters/.

Current economic experts believe inflation will approach 2.0% in the coming year. However, the impact of Health Care Reform and the deficit loom large over 2014, making projections murkier than ever. Reasons for a rise include small increases in labor cost and higher increases in costs of commodities. These factors directly contribute to price increases.

The Federal Reserve continues to be alert to trends in inflation, but it has likely stoked a potential bonfire with multiple years of “quantitative easing”.  The Fed’s current monetary policy is designed to promote economic recovery, leading to short term central bank nominal interest rates remaining effectively at zero but also increasing the risk of inflation.

With current facts and new issues in mind, a reasonable 2014 estimate of base annualized CPI increase is 2.0 to 3.0%.  You may assimilate other information pertinent to veterinary medicine and your specific practice, such as predicted increases in drugs costs and employee benefits like group health insurance premiums. Your resulting estimated practice inflation rate can be used to plan an updated fee schedule. Spreadsheet software helps simplify the calculation by applying proposed rates to existing fees, one by one.

These days, most practices run on veterinary practice production software, with current service codes and prices already on board. Use the global price increase function to raise all charges by the chosen percentage.

Remember,  the  selected  percentage  depends  on  how  often  you  adjust  fees  for  inflation. Assuming regular increases on a quarterly basis, divide the prospective annual increase in the CPI by four. Implementing an annual estimate of 3.0%, division by four quarters equates to 0.75% per quarter. Three-quarters of a percent is then the amount to use as a global price increase. The total annual rate of increase will be higher, due to the effect of compounding, an extra bonus for attentive management.

This low rate of increase must be faithfully carried out over all four quarters with global application in the practice software. Also, your locale may have a higher projected increase. Certain U.S. cities can vary in inflation effect by 20% to 30%.

After implementing an increase, you may decide to round up the fee result.   Many practice owners are adverse to professional services fees that are not round numbers. Some practice managers round up to the nearest nickel. Other more self-confident administrators round to the nearest dollar. But there is nothing wrong with omitting the rounding convention.

Before finalizing the updated fee schedule, evaluate so-called “shopped” services for reasonableness.  Experience, knowledge of the local market surrounding the practice, and cost analysis are crucial in determining the final price for specific individual services.   In recent years, it has been a difficult challenge to determine the upper limits of what the market will bear in charging for services. Specific “shopped” services may not allow increases, even for inflation. Maintain such services at what you believe to be the optimal rate and circle back to them regularly  for  verification  of  transactional  volume,  client  feedback,  and  competitor  price espionage.

Cost analysis yields specific information about service generation. The cost of some services, shopped or otherwise, far surpasses the price commanded. Highly labor-intensive services such as low-volume boarding are an example. Losses incurred from a service may more than negate any benefits provided to the practice as a whole. Even a price increase based on inflation may be inadequate to cover costs of providing a service. If so, an additional adjustment of the price upward to reach a breakeven point is justified. Another option is discontinuation of the service.

As facility, employee, and vendor costs increase, so too must fees. Inflation will eat away at profit margins unless practice managers are proactive. The cost of doing business is going up from many factors that are outside of a practice’s control. Protect your practice’s profit margin by monitoring inflation with the CPI and raising fees accordingly.

Marsha L. Heinke, CPA, Inc.

934 Main Street

Grafton, Ohio  44044

Phone: (440) 926-3800

Fax: (440) 926-3801 

www.VPMP.net

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