Joy Fuhrman, DVM, MBA, CPA
Director of Finance and Operations
Cost of Goods Sold (COGS) represents one of the largest expenses in any veterinary practice. Therefore, closely managing this expense is critical to overall financial success of the business. AAHA and other well-managed practices report average Costs of Goods Sold (COGS) of been 22% and 25%. However, by applying the principles discussed below, you can reduce COGS to as low as 8-12% depending on your practice type. That’s extra money that can be spent on employee salaries or new equipment for the practice. But let’s dispense the myth that keeping your COGS low requires you to spend endless hours each month counting every inventory item on your shelves or analyzing and tracking the changing costs of each item. Who has time for that anyway?
So how can you benefit from reduced inventory costs and save time spent on ordering and managing inventory? To start, you need to first ask yourself if you understand your inventory.
Do You Understand Your Inventory?
Whether you feel lost when it comes to your practice’s inventory or you feel like you have inventory under control, now is the time to sit down and analyze your inventory usage. Additionally, you should repeat this analysis at least every three to six months because (no surprise here), product usage changes with seasons, doctors and even patients. Also, the availability and pricing of certain products may push you to use alternatives.
To understand your inventory usage (and by extension your Costs of Goods Sold), determine the answers to the following questions:
- What are the most commonly used products in your practice?
- What are the products that you absolutely cannot run out of (e.g. emergency drugs?)
- How much do you use of each product?
- What is the minimum amount of each product that you need to keep on the shelf?
- How long does it typically take for your orders to be delivered?
Categorizing Your Inventory Items
Categorize each of your inventory items into the following categories:
AA: Must never run out!
A: Important but you have a back-up plan.
B: Rarely used but you must have this in the practice.
C: On the chopping block!
Category AA: Must never run out!
AA includes drugs that are used every day in your practice such as vaccines, Cerenia, non-steroidal anti-inflammatories, etc.
Non-drug AA items might be surgical gloves or possibly blood product filter lines if you are in emergency practice.
Category A: Important but you have a back-up plan.
Category A items would include regularly used antibiotics or other drugs that you would not want to run out of except that you have a backup such as a different milligram tablet that could be split into two or possibly a liquid formulation. An example would be Clavamox 62.5mg tablets. If you ran out of this drug, you could easily prescribe the Clavamox 125mg tablets and order a half a tablet twice a day. Alternatively, you could prescribe the Clavamox 62.5mg/ml liquid formulation.
Non-drug category A items might include 3cc syringes. You definitely don’t want to run out of these! But if you did, you would have 6cc syringes as a backup.
Category B: Rarely used but you must have this in the practice.
Category B items might include emergency drugs such as atropine or epinephrine. Even though these items may rarely be used in your practice, you never want to not have them on hand when you need them.
Category C: On the chopping block!
Finally, category C items are those products that you ordered once and used only a couple times. This includes the heartworm preventative that you thought you would try but didn’t really like or the food that you special ordered for a client that is no longer with your practice.
Categories will be unique to your practice.
It is important to keep in mind that these categories are very specific to your practice. What might be a category AA item for one practice, could be a category C item for another practice. You need to be in tune with your practice’s culture and your doctors’ philosophies about how they choose to practice medicine. The types of patients you see will also dictate to a large extent how you categorize your products. Think emergency practice versus day practice. Or feline only clinics versus large animal practice.
Finally, product categories may also be affected by availability of product. For any emergency clinic, Fentanyl might be considered an AA product. However, current opioid shortages have likely pushed Fentanyl to an A category product!
The idea behind this inventory management philosophy is to order your products so that they arrive “just in time” before you run out. In order to maintain such a system, you need to understand the following terms with respect to each product:
- Turns: the number of times the product is sold or used in a time period such as a month or a week.
- Reorder Point: The level of inventory which triggers an action to order more of that item.
- Lead Time: The time it takes a supplier to deliver the products once an order is placed
Speak to your distributor rep and request a 12 to 24 month history of your orders. This will help you identify your turns, lead time and determine an appropriate reorder point for each product.
It is probably not necessary to count all of your inventory every month. However, it is important to perform some inventory counts on a regular basis to maintain control and minimize inventory shrinkage. Some practice managers—especially those with a background in retail—may elect to NOT count inventory and to manage their inventory on a perpetual system. This means that the value of inventory on hand is calculated based on the purchasing and sales records. The shortcoming of this method of valuing inventory is that it does not account for any shrinkage—products that leave the practice, whether through theft or through unintentional neglect in capturing charges on client invoices. Additionally, a perpetual inventory system does not adequately account for usage of drugs and products in the clinic. For these reasons, we do not recommend using this type of inventory management system in veterinary practice.
By cycling your inventory counts by area, you can reduce the amount of time you spend on any given day counting your products. You may choose to cycle your counts based on either location e.g. pharmacy, treatment, laboratory, central storage etc., or on type of inventory e.g. injectables, prescription drugs, surgery supplies, etc. In general, we recommend counting one inventory location or type every week on a 6- to 8-week cycle. Of course, this may vary depending on the number of locations or inventory categories in your practice and on the product usage or turns in your practice.
Budgeting for Your Orders
Many practices place their inventory orders based on history and possibly on bulk promotions being offered by distributors. However, the best way to keep your COGS down is to base your orders on anticipated usage using your budgeted or expected revenues and your current and targeted COGS percentages as a guideline.
First, determine what your expected daily revenues are for each day in the upcoming week. Second, multiply the daily revenue budget by your current COGS percentage and your COGS percentage goal to determine the maximum and minimum amounts that you should budget to spend on inventory purchases for the week.
Next, track the cost of each vendor’s orders and the cost of all orders for the week. Also track the cost of the products actually received since this will sometimes differ from the order due to vendor errors and products being on backorder. Finally, calculate the COGS percentage for the orders placed as well as for the products received.
Get started and download a fillable spreadsheet with these calculations.
Timing Your Orders to Maximize Cash Flows
It is important that you understand exactly when your distributors’ cut-off dates are scheduled so that you can time your orders appropriately to maximize your cash flows. Using a credit card to pay your distributors’ will also help to maximize cash flows, provided you pay the credit cards off each month. You will also earn rewards points that can be used for continuing education travel costs or employee incentives! Paying for inventory purchases every 60 days (using a credit card) rather than monthly or weekly will a) give you more money in the bank in case of an emergency, b) earn you more interest, and c) get you a bunch of credit card rewards points!
Download an example of how this works.
Inventory Standard Operating Procedure
All practices should take the time to create an inventory standard operating procedure to help provide consistency for the team and document processes. Having an inventory SOP provides the ability for the team to contribute and understand the processes. Also, the only way to manage your COGS at a low percentage is to have your whole team buy-in. It is important for the team to be onboard and understand the value of managing COGS at a just-in-time inventory level. It is recommended to have digital access to your inventory manual so it is available for internal use and reference at all times. This can be set up utilizing Dropbox, iCloud, Google Drive, etc.
Inventory SOP Sample Outline:
-Order cut-off dates
- Controlled Substances (based on DEA and State requirements)
- Invoice Processing
- Counts (cycle counts performed on a rotating schedule)
Other items to be included throughout the inventory SOP:
- Links to other SOPs, resources, internal forms/documents, etc.
- Password security to sensitive items
- Screenshots of processes
With COGS being one of the largest expenses, it is imperative to closely manage this expense, but remember, you don’t have to spend endless hours on it each month. By applying the practices suggested here, you can reduce your COGS and improve the practice cash flow. Who doesn’t want extra time and money for their practice?
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