inventory management

Inventory Management

A Key to Success

Terms

• distributor / vendor / supplier are used interchangeably. It is the entity that you are purchasing drugs and supplies from. It can be the manufacturer or a distributing company

• Inventory / supplies is used interchangeably. It is the actual item that is purchased.

• Inventory management is a critical component of practice profitability

• It is the second largest cost of operation of the veterinary practice

• Remember, the first largest cost is staffing

• Lack of effective inventory systems is a common cause of poor cash flow in a veterinary practice

• In most practices a veterinary technician is put in charge of all or parts of the inventory management system

• Inventory is specifically defined as all the goods owned and held for sale or use in the regular course of business

• This includes:• Drugs and supplies purchased to resell to

clients (dispensing items)• All inventory items used to provide medical

and surgical services• Office and computer supplies• Cleaning and janitorial supplies• Maintenance supplies

• Inventory control is the process whereby the need to maintain sufficient inventory to meet the hospitals needs is weighed against the cost of carrying the inventory

• Tax definitions of inventory may be different

• Optimum inventory control ensures that the practice will never be out of a needed item and that the cost of purchasing and carrying inventory is kept to the lowest possible level

3 Costs Associated With Inventory

• Unit Cost

• Ordering Cost

• Holding Cost

Unit Cost

• The cost for each item of inventory purchased must be calculated for the unit it is used or dispensed in.

• This is called the unit price

• The unit price of the item includes:

• Sales tax charged to the practice by the vendor on each item sold to the practice (not charged by vendor in all states, but it is charged in New York State)

• Shipping costs

Ordering Cost

• Most ordering costs are labor-related expenses:

• Hourly wage paid to the employee performing the work

• Associated payroll taxes

• Employee benefit programs

Labor Cost Includes the Following Tasks

• Determining the amount needed

• Shopping for the best price

• Placing the order

• Meeting with the manufacturing representatives

Labor Cost Includes the Following Tasks

• Accounting for back orders

• Receiving and unpacking the orders

• Comparing the purchase order with the shipping invoice

• Pricing and placing the items on the shelf

Labor Cost Includes the Following Tasks

• Posting the costs of the items in the practices disbursement register

• Providing statements to be paid to the appropriate person (bookkeeper, practice manager, etc)

• Logging the appropriate Controlled substance items

Labor Cost Includes the Following Tasks

• The entire inventory ordering activity expends quite a bit of employee time

• Ordering costs can account for a much as 15-20% of the total unit cost

Holding Costs

• Holding costs are the costs of owning and keeping inventory on the premises in anticipation of use.

• The largest holding cost is the capital tied up in purchasing the inventory

Holding Costs Also Include

• Personal property taxes paid on the inventory value as of a specific valuation date. (usually end of year to the IRS)

• Insurance premiums paid on the average value of the inventory to protect against the risk of loss in the event of a disaster, theft, or damage

Holding Costs Also Include

• The cost of protecting inventory from heat, cold, humidity

• Costs associated with outdating and spoilage, especially if inventory is not used or sold immediately

Holding Costs Also Include

• Pharmacy licensing fees in states where applicable (In NYS there is no licensing fees, but a veterinary pharmacy is under the same regulations as the human pharmacies)

• The cost of maintaining OSHA regulation compliance

Holding Costs

• The proceeding holding costs range from 8-15% of the unit cost

• The holding and ordering costs, combined, comprise 25-40% of the total unit cost depending upon:•

Combined Holding & Ordering Costs

• The holding and ordering costs, combined, comprise 25-40% of the total unit cost depending upon:• Amount of time inventory is held (on the shelf)• Success of discouraging pilferage (theft)• efficiency of purchasing

• Inventory costs amount to much more than what is paid to the vendor

• Optimum inventory control includes an astute purchasing policy that minimizes ordering and holding costs while at the same time ensuring that the items required to operate the hospital are available when needed

Goals of Inventory Control and Management

• If inventory control and management are effective, the following should be true:

• Medications and supplies are available to treat patients when needed

• Clients can obtain refills and other items when requested

• Quantities of drugs and supplies are controlled to minimize hospital expenditures to the lowest practical level. Large stock quantities that tie up cash are avoided unless discount savings can be shown to adequately offset the dollars tied up in idle inventory amounts on the practice shelves

• Staff can efficiently order, stock, and dispense the needed items

• Controlled drugs are properly monitored and secured

• Appropriate security systems and safeguards exist to insure that drugs and supplies will be used as intended

• Staff is trained to correctly handle supplies that represent potential health and safety hazards

• Fees charged for pharmaceuticals and supplies are adjusted on a regular basis and price increases are appropriately passed on to the client

• The desired level of profit is achieved

• To accomplish this, a workable hospital inventory system must be:• Planned• Organized• Directed• Evaluated• Adapted as needed

Effective Inventory System Functions

• Ensures that all items used in the hospital are available when needed

• Signals the manager when an item needs to be reordered to avoid running out of stock

Effective Inventory System Functions

• Accounts for the estimated delay between placing and receiving an order

• Should keep supply levels that do not unnecessarily tie up capital

• The accounting and reporting system should be flexible

Effective Inventory System Functions

• Provide accurate detail of inventory on hand and it’s value at any given time. (perpetual inventory)

• Act as a contact management tool – names, phone numbers, account numbers of vendors, log of prior orders

Effective Inventory System Functions

• Should readily identify where each item is available at the least cost, how to order, and any quantity discounts if applicable

• Identify and track backorders and when they will arrive

Effective Inventory System Functions

• Track expiration dates so product can be returned for refunds and taken out of quantity on hand stock

• Identifying factors such as seasonal usage, to better help with projecting ordering quantities

Effective Inventory System Functions

• Should help verify that received orders agree with purchase orders

• Should allow for price increases by vendors to automatically adjust dispensing price to client

Effective Inventory System Functions

• Should reduce pilferage and theft by employees

• Should easily identify wastage and other forms of loss

Pareto’s Law

• The 80/20 rule • States that 20% of the inventory items

account for 80% of the annual inventory expenses

• This should be taken into account when determining the ideal turnover rate for the item

Inventory Management Systems

• Can be either a manual card system or computerized

Inventory Management Systems

• They must contain the following item information:• Item – size, color, strength, dispensing format

(pill, capsule, liquid, paste, can, case, etc)• Supplier – company name, phone #, hospital

account #, discount information, billing policy

Inventory Management Systems

• Quantity – amount of each item ordered, price quoted, date ordered, number of each item received, date received and invoice price

• Reorder point – maximum and minimum level of stock at which reordering should occur

Inventory Management Systems

• Invoice costs – price per item or unit, sales taxes, shipping, handling and freight charges

• Storage location in hospital – in hospital use and/or dispensed, areas where kept, at what levels should restocking of secondary locations take place (ie. Treatment area, surgery, exam rooms, display shelves, pharmacy)

Inventory Management Systems

• Price to client – formula for determining price to be charged client, including dispensing fees, minimum price, bulk purchase price, markup over unit cost

With this amount of information, abbreviations are frequently used, information is customized and organized by the user

• See handout on manual inventory system

• Separate lists would have to be kept for vendors, contact #, account #, etc

• Computerized inventory system will be shown later

• Whomever is selected as an inventory manager must be able to maintain a working relationship with the vendors, but can not develop unfair biases for or against a particular vendor.

• It is best to price shop vendors and deal with a small group of vendors instead of a large number of them

Determining What, How, When and How Much to Order

• Remember the “80-20 rule” – that 20% of the products account for 80% of sales or use

• Figure out which products make up the 20% and pay special attention to them.

• Make sure not to overstock products that make up the other 80%

• The key to an efficient and effective ordering policy is being familiar with the suppliers and a good knowledge of how the items are used in the practice

• This knowledge will make it possible to order the right amount of goods at the least expensive rate

Determining quantities and timing

• Know when drug representatives will be visiting the hospital. Being prepared saves lives.

• Keep a list of the items that need to be reordered from each supplier prepared

Determining quantities and timing

• Deal with as few suppliers as possible

• Anticipate seasonal needs for some supplies

• Most vendors “close their books” between the 25th and 30th of the month. Try to order large amounts after that date so you will not be billed till the next month

Determining quantities and timing

• Try to take advantage of vendor discounts (ie.) 1% discount if statement is paid within 10 days

• Try to avoid ordering small quantities that may bear additional shipping charges

• Avoid late payment finance charges

Determining quantities and timing

• To properly plan for proper inventory levels, you should periodically analyze each item or class of items to:

• Forecast demand for the next month, quarter, or year, including seasonal trends

Determining quantities and timing

• Estimate the lead time• Plan usage during the lead time• Establish and monitor quantity on hand• Determine safe reserve of stock requirements• Place items on order

Inventory Turnover

• The higher the inventory turnover for a given period of time, the more efficient the inventory control

• Best to try for 8-10 times per year. This averages 35-45 days on the shelf

Determining the Inventory Turnover Rate

• Beginning inventory + ending inventory

________________________________ = average inventory on hand

2 for that period

total purchases between inventory dates

___________________________________ = inventory turnovers

average inventory

365 days

_______________________________ = average shelf life in days

inventory turnovers per year

Determining the Inventory Turnover Rate

• For whole inventory annual turnover and single item annual turnover

• see handout

Determining When to Order

• 3 factors control the timing of orders:

• The time needed for delivery• The rate of inventory usage• The safe stock levels

Example

• Assume that an inventory turnover rate is 6 (average inventory is used up in 60 days)

• If you have 30 days to sell the item before you need to pay for it, and if the selling price is double the purchase price.

• From the sale of a 30 day supply(1/2 of the order) you have taken in in revenue the amount of money you need to pay for the whole order

Product Pricing

• Inventory is an asset to the practice

• It is nonproductive until it is used or sold

• Until that happens, it costs the practice money

Product Pricing

• An adequate charge needs to be assessed and collected from the client

• Otherwise, no matter how well the expense side of inventory is managed, there is no profitability to the practice

Product Markup

• Adequate and timely product markup is necessary

• 100% = 2 X cost• 200% = 3 X cost• 300% = 4 X cost

Product Markup

• Markup can range from a low of 40% to a high of 400%

• A 40% markup prices the product very close to the break even point

Product Markup

• Some inventory items have a recommended dispensing price by the manufacturer. This can range from 40-45% markup.

• Example : prescription dog foods

Product Markup

• High cost items are usually given a low markup % to keep the pricing reasonable

• Many times flea/tick products and heartworm preventative is given a low markup to keep competitive with the online pharmacies

Product Markup Example

• A bottle of 500 amoxicillin 500mg capsules costs: $54.95

• Sales tax: 4.47• --------------------------• Total cost: 59.42 for bottle of 500 caps• cost per capsule $0.12

Product Markup Example

• At $ 0.12 per capsule

• 100% markup = .24 dispensing price• 200% markup = .36• 300% markup = .48

Product Markup

• A dispensing fee is usually added to items that have to be counted out and put in other containers

Sales Tax

• In New York State we pay sales tax on all the products we purchase from the vendors.

• We add sales tax we pay into our calculation of product unit cost

Sales Tax

• The state tells every type of business which items they must charge sales tax on when they are purchased by the client

• Fortunately in veterinary medicine, we have a very few items we need to charge sales tax on

Sales Tax

• Examples:• Boarding and grooming• Cremations• Collars, leashes• Pet toys

A copy can be obtained from NYS Dept of Taxation

• Reference materials from:

Practice Made Perfect by Marsha Heinke, DVM, EA, CPA, CVPM and John Mc Carthy, DVM, MBA