Will you prepare a budget to better manage the upcoming year—or miss the opportunity and later wonder why your agency underperformed?

For most calendar-year home health agencies, serious budgeting for the upcoming year should begin around October 1.

But if your agency has never prepared a meaningful financial-operational budget—or if your current budgeting process consists primarily of taking last year’s financial results and adjusting them by a few percentages—I would start earlier.

Early September is not too soon.

A worthwhile budget takes time. Historical information must be gathered and analyzed. Assumptions must be developed. Financial and operational relationships need to be understood. Management needs to review and challenge the projections. Changes will need to be made. The budget may go through several iterations before it is ultimately approved.

If this is your first serious budgeting exercise, the objective should not be to finish the budget quickly.

It should be to finish with a budget worth using.

And a budget worth using should do more than project revenue and expenses. It should incorporate enough of the agency’s underlying financial and operational drivers to establish meaningful expectations, identify measurable Key Performance Indicators (KPIs), and provide management with something against which actual performance can be evaluated throughout the upcoming year.

And that distinction matters, because preparing the budget is only the beginning.

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Your Budget Will Be Wrong

Let’s get that out of the way right now.

A budget is an estimated projection of future financial and operational performance. It will not be perfect—and it isn’t supposed to be. The objective isn’t perfection. It’s to establish the most reasonable expectations possible with the information available at the time.

You are attempting to project what will happen in the future. A future that cannot be predicted with certainty.

Patient volumes will differ from expectations. Payor mix may change. Wage rates may increase more or less than anticipated. Employees will leave and others will be hired. Medicare reimbursement will change. Contract rates may change. Utilization will fluctuate. Referral sources will change. Unexpected expenses will occur.

That doesn’t mean the budget was unsuccessful or not worthwhile.

The objective of budgeting is to establish reasonable, supportable expectations based upon what management knows today and then measure actual performance against those expectations as the budgeted year unfolds.

In fact, one of the benefits of Budget-to-Actual analysis is discovering where and why your assumptions were wrong.

That information should improve the next forecast, the next budget, and ultimately management’s understanding of the agency.

Budgeting precision should improve with experience.

But that only happens if management actually learns from the differences between what it expected to happen (the budget) and what actually happened. And that only happens when you use the budget to measure your results throughout the budgeted year.

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Some Agencies Have a Significant Head Start

In a perfect world, every home health agency would perform some level of Financial-Operational Analysis (FOA Review) shortly after closing its books each month.

Unfortunately, many (maybe even most) do not.

A meaningful FOA Review should bring financial and operational information together so management can identify and monitor the KPIs that explain how the agency is performing (for example, do you know what your Direct and Total RN CPV was for May, June, July, etc.? Do you know what your Days of A/R and Days of A/P were for each month this year? You should.).

Depending upon the organization, that might include patient census and admissions by payor, revenue and reimbursement metrics, visits and utilization by discipline, Costs Per Visit (CPVs), staffing and productivity measures, payor mix, margins, LUPAs, Outliers, and other financial and operational relationships important to that particular agency.

And these shouldn’t simply be individual monthly numbers.

Viewed month after month, those KPIs begin to identify trends and the agency’s business cycle.

Does census normally decline during certain months?

Does utilization change seasonally?

Do staffing costs move with patient volume?

Does a particular payor become a larger or smaller percentage of the business during different portions of the year?

Do certain CPVs consistently increase during periods of lower volume?

An agency that performs a meaningful Financial-Operational Analysis shortly after closing each month already has much of the foundation necessary to prepare its budget.

Because of these ongoing Financial-Operational Analyses, management should already know its KPIs, understand their historical trends, recognize seasonal changes, and understand many of the relationships between patient volume, utilization, staffing, reimbursement, costs and profitability.

They’re not beginning budgeting season by trying to figure out how their agency operates. They’ve been studying it all year.

That is a significant advantage.

Agencies without that information can still prepare a worthwhile budget. But the first part of the budgeting process will probably require more work because management must develop some of that understanding while simultaneously trying to project the upcoming year.

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Please Understand that Revenue Is Not a Driver of Revenue

This is where many budgets begin to lose much of their potential value.

Management looks at last year’s revenue, assumes growth of 5%, and budgets:

Prior-Year Revenue × 105% = Next Year’s Revenue

The calculation may be easy.

But what caused the revenue to change?

Revenue is an outcome. It is not a driver of itself.

For a home health agency, a more useful revenue budget should begin as close as reasonably possible to the underlying drivers of that revenue.

That generally means starting with patients, admissions and/or census by payor, and then applying the appropriate reimbursement assumptions for those payors.

For Medicare, additional factors may include payment-rate changes, payment periods, Case-Mix Weights, wage index, LUPAs, Outliers, HHVBP adjustments and other applicable reimbursement variables.

For Medicare Advantage and other payors, reimbursement may be based upon episodic/PPS-like payments (likely discounted), per-visit rates, negotiated case rates or other contractual methodologies.

The point isn’t that every budget must model every claim.

The point is that the budget should begin with the business activity that generates the revenue, rather than treating revenue as though it generates itself.

Why does that matter?

Suppose three months into the year revenue is $100,000 below budget.

If the budget started with a revenue assumption (no other drivers), management may know little more than:

Revenue is $100,000 below budget.

That’s a variance.

But why did it happen?

The budget can tell us no more.

Now suppose the budgeted revenue was developed from projected patient census by payor and the expected reimbursement associated with those patients.

Management may discover that:

• Medicare census is below budget;
• Medicare Advantage census is above budget;
• Medicare reimbursement per payment period is approximately on budget; and
• the change in payor mix explains much of the overall revenue shortfall.

Now management knows considerably more than simply, “Revenue is below budget.”

It has information about why revenue is below budget.

And that gives management an opportunity to determine whether something can or should be done about it going forward.

A variance tells you that something happened. A well-constructed budget can help tell you why it happened.

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Expenses Have Drivers, Too

The same principle applies to expenses.

Simply taking last year’s clinical labor expense and increasing it by 4% may produce a number, but it doesn’t necessarily produce a useful budget.

Clinical labor should be developed around the disciplines the agency uses—or expects to use during the upcoming year.

That may include:

RN, LPN/LVN, PT, PTA, OT, COTA, ST, MSS and HHA.

If patient volume drives visits, and visits drive clinical staffing requirements, then those relationships should help drive the budget.

The progression might look something like:

Projected Patients → Projected Utilization/Visits by Discipline → Staffing & Productivity Requirements by Discipline → Compensation Assumptions → Projected Clinical Labor Costs

The more accurately those relationships reflect how the agency actually operates, the more useful the budget becomes when actual performance begins to deviate from expectations.

And the same concept can be applied throughout the organization wherever a meaningful driver can reasonably be identified.

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Write Down Your Assumptions

This sounds simple.

It is also one of the most frequently overlooked parts of budgeting.

Every meaningful budget contains assumptions, such as:

What census are you expecting?

What wage increases have you assumed?

What Medicare reimbursement changes have been incorporated?

What HHVBP adjustment was used?

What utilization assumptions were made?

When is the new branch expected to open?

When is the new contract expected to begin?

What inflation factor was applied to supplies?

What productivity expectations were used?

Memorialize those assumptions.

Make them a permanent part of the budget documentation.

Do not rely upon someone remembering why a particular number was used.

Weeks—or sometimes even days—later, the reasoning behind an assumption may no longer be clear. Months later, someone performing a Budget-to-Actual analysis may be looking at a variance without remembering what management originally expected to happen.

The assumptions provide that context.

For example:

RN compensation projected to increase 4.0% effective January 1.

Medicare ADC projected to increase from X to Y during the year.

2027 Medicare reimbursement based upon the CY 2027 Final Rule.

HHVBP payment adjustment assumed at X%.

New managed-care contract assumed to begin April 1.

The numbers tell you what was budgeted.

The assumptions help explain why.

The assumptions are not merely supporting documentation for the budget. They are part of the budget.

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Does Every Agency Need a Full Budget?

No. At least not initially.

Particularly for an agency that has never prepared or actively managed from a meaningful budget, there can be considerable value in starting with something more manageable.

I generally think about this in terms of a Starter Budget and a Full Budget.

The Starter Budget

A Starter Budget is intended to provide meaningful value without requiring the time, complexity and detail of a Full Budget.

Revenue and expense categories will generally be more highly grouped. Fewer operational measures and KPIs will be projected.

But it should still be more than a projected Income Statement.

A worthwhile Starter Budget should incorporate enough financial and operational information to help management understand the relationships driving the agency and provide useful measures against which actual performance can be compared during the budgeted year.

There is another benefit.

As management begins using the Starter Budget, it will often discover additional questions it would like the budget to answer.

Those questions begin demonstrating the value of the additional KPIs and detail available through a Full Budget.

The Starter Budget therefore isn’t simply a smaller budget.

It can also be an introduction to what budgeting can become as a management tool.

The Full Budget

A Full Budget goes considerably deeper.

Depending upon the size and complexity of the organization, it may incorporate multiple business lines, revenue centers, cost centers, payors, disciplines, staffing models, productivity measures, utilization assumptions, reimbursement metrics, CPVs, margins and numerous other financial and operational KPIs.

A meaningful Full Budget can easily require 50 to more than 200 hours to develop, review, revise and approve, depending upon the agency’s size and complexity.

But “Full” does not mean every possible item must be separately projected.

Consider an agency with more than 100 insurance payors.

There may be little management value in individually budgeting every low-volume payor. The larger, higher-volume payors may appropriately stand on their own, while smaller payors with sufficiently similar reimbursement or operating characteristics may be grouped.

Detail should exist where the detail adds management value.

A Full Budget should be detailed enough to explain and manage the business—not so detailed that maintaining the budget becomes the business.

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The Budget Is Finished. Now the Real Work Begins.

The budget has been prepared.

Management has reviewed it.

Changes have been made.

The assumptions have been documented.

The Board, owner or appropriate leadership has approved it.

Finished?

Not even close.

This is when much of the real value of budgeting begins.

Once approved, the budget becomes a static document.

It memorializes what management expected the upcoming year to look like based upon the information and assumptions available when the budget was approved.

Do not continually rewrite that history as actual results become known.

Instead, compare actual performance with the approved budget.

Every month.

Ideally, Budget-to-Actual analysis should begin with Month 1. However, if an agency isn’t ready immediately, I would recommend that the process start no later than Month 1 of the second quarter (the fourth month of the budgeted year).

And the comparison should include both:

Current Month: Budget vs. Actual

and

Year-to-Date: Budget vs. Actual

Material dollar and percentage variances should then be identified and investigated, such as:

Revenue is below budget.

Why?

Nursing CPV is above budget.

Why?

Visits per patient are higher than expected.

Why?

Census exceeded budget, but profitability declined.

Why?

Contract labor is significantly above budget.

Why?

Medicare revenue exceeded budget, but Medicare margin did not.

Why?

The objective isn’t simply to produce a variance report.

The objective is to understand what caused the variance and determine whether—and how—management should address it..

And each time management does that, it learns something else about the agency.

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The Budget Is Static. The Forecaster Should Be Alive.

Although the approved Budget should remain static, that doesn’t mean management should continue pretending in September that everything originally projected for the remainder of the year will still occur.

That’s where a Forecaster becomes valuable.

I sometimes refer to it as the agency’s “Living Budget.”

The Forecaster combines actual financial and operational results with the remaining budgeted—or appropriately revised projected—results for the rest of the year. For example:

Suppose May has just closed.

The Forecaster might now contain:

January through May → Actual financial and operational results

June through December → Budgeted/projected financial and operational results

When June closes:

January through June → Actual

July through December → Projected

And so on.

But the remaining months don’t necessarily have to remain identical to the original budget.

Management now knows things it didn’t know when the Budget was prepared and approved.

Perhaps census growth has been slower than expected.

Perhaps wages increased more than anticipated.

Perhaps utilization has changed.

Perhaps a major referral source was gained or lost.

Perhaps a new payor contract was signed.

Perhaps reimbursement assumptions have changed.

The Forecaster can incorporate that new information without changing the original Budget.

That distinction is important.

The Budget tells you:

What we expected to happen.

Actual results tell you:

What has happened.

The Forecaster tells you:

What our financial and operational results are now projected to be at year-end.

With each month that closes, another month of estimates is replaced by actual information.

Properly maintained, the Forecaster should therefore become increasingly precise in estimating the agency’s likely year-end financial and operational results.

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And Then You Do It Again

This is where budgeting stops being an annual accounting exercise and becomes part of an ongoing financial-operational management system.

The process should look something like this:

FOA Review → Budget → Budget-to-Actual → Forecaster → Better Understanding → Next Year’s Budget → Repeat

There really isn’t an endpoint.

It is a continual learning loop.

Monthly FOA Reviews improve management’s understanding of the agency’s KPIs and business cycle.

That understanding improves the Budget.

Budget-to-Actual analysis identifies where expectations and reality differ—and why.

The Forecaster incorporates what management has learned and improves its estimate of where the agency is going.

Those experiences then improve the assumptions underlying the next year’s Budget.

And the process begins again.

Better Information → Better Decisions.

The first serious budget may be challenging.

The second should be better.

The third should be better still.

An agency that already performs monthly FOA Reviews has a significant head start because it enters budgeting season with objective, quantifiable historical information and established KPIs rather than beginning with guesses.

But even an agency starting from scratch should become better at budgeting each year if it actually uses what the process teaches it.

Every year should improve management’s understanding of the agency and its business cycle.

Every year should improve budgeting precision.

And every year should provide management with better information from which to make decisions.

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A Budget Should Help You Manage the Agency—not Simply Attempt to Predict the Future

A worthwhile budget should do more than attempt to predict how much revenue you will generate, how much money you will spend, or what your profit or loss will be at the end of the year.

It should help you manage the agency throughout the year.

It should reflect how your agency works—the patients you expect to serve, the payors responsible for those patients, the reimbursement you expect to receive, the resources required to provide the care, the costs you expect to incur, and the financial and operational relationships necessary to produce the results management expects.

That is one reason preparing a meaningful annual budget can be one of the best exercises for developing a more intimate understanding of your agency.

But completing the budget is only the beginning.

Use the FOA Review to understand where you’ve been and what is happening now.

Use the Budget to establish where you expect to go.

Use Budget-to-Actual analysis to identify where expectations and reality are diverging—and understand why.

Use the Forecaster to determine where you now expect to finish.

Then take everything you’ve learned and use it to prepare a better Budget next year.

And do it again.

And again.

Because this isn’t sophisticated financial theory.

It is a fundamental business discipline—and every home health agency should be doing it.