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The Materials Management "Tip O' The Month" for the month of:

May, 2007

Question:

"Multiple year cost savings - When you complete the financial analysis for a product line and see that you can save money over your current price for a competing product and you make the conversion, for what time period can you report the savings? If your new agreement is for 3 years and you save 10% over your current price, do you report the savings for the life of the contract? For the current fiscal year? For a calendar year? Are there any generally accepted accounting principles for capturing supply cost savings that cross over multiple years? "

Response:

A savings identified between two products would only be for the first year of operations (the first 12 months of having the product in place), since I try to measure everything and normalize in terms of an annual impact.

When you implement a product which brings recurring savings, this now creates a conundrum for years 2, 3 and onward because:

If additional (that's the key word) savings are experienced in year 2 above & beyond those experienced in Year 1, then those are your Year 2 savings. If they are mostly more of the save incremental savings as Year 1, then the Year 2 savings do not count. The answer's simple because you've got a basis for costs. When you change that cost basis, your formula for determining savings must change, also.

Think of it like the last time you filled up your car with gasoline. It wasn't that long ago that a gallon of gas rose to be over $3.00, or more, per gallon. Now that gasoline is $2.50 - $2.60, is this a cost savings? I say "Hell no. Gas shouldn't cost any more than $1.50 a gallon!"

So, the basis for determining a cost savings when implementing a product change is the determine how much more incremental savings this product would achieve in year 2 over year 1. If your answer is substantial, due to an increased case-mix index of patients using the products or an increase in volumes or acuity - then, and only then - can you "take credit" for ONLY the incremental increase in cost savings OVER YEAR 1.

Year 3 is handled in the exact same manner. Only consider an incremental increase in cost savings over year 2 and nothing more. Your savings will probably be dwindled down by the end of year 3, anyway.

We hope that this tip help you get you arms around multiple year cost savings - once and for all!


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