Understanding Pharmacy Financials II: Cost of Goods Sold

Understanding your Income Statement

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Part 2 – Cost of Goods Sold

As an independent pharmacy owner you may tend to focus more on the health and services side of your business than on its numbers. While you may leave the heavy lifting of the business’ books to your accountant – after all, that’s why you hired one – it pays to have an understanding of your pharmacy’s financials.

When you’re familiar with the numbers side of your business you’re aware of your pharmacy’s fiscal health, which is one of the keys to its success.

Here, we continue to examine the components of your business’ Income Statement with Cost of Goods Sold (COGS).

What it is

In a retail business, such as your independent pharmacy, Cost of Goods Sold is simply the cost of the merchandise (or inventory) that you buy from a supplier, which you then resell to your customers. COGS does not include operational expenses, such as labor, utilities, rent, salaries, and other overhead.

Delving a little deeper, Cost of Goods Sold is treated as an expense, which is deducted from your Revenue (or Sales) to determine Gross Profit (more on the latter can be found in Part 3 of this series.)

Why it’s important

When you properly manage your Cost of Goods Sold, you maintain greater control of your pricing strategy as it relates to prescription revenues (i.e. proper reimbursements and cash pricing), as well as, non-prescription products such as OTC, DME, etc. Remember:

Revenue – COGS = Gross Profit.

Therefore, by properly pricing the items that your pharmacy sells, you can generate more revenue.

Proper inventory management is a key component to maintaining a realistic COGS. Click To Tweet

Typically, the two largest inventory items purchased by a pharmacy will be brand and generic pharmaceuticals. Depending upon the pharmacy’s product mix, it may need to purchase items with a higher cost (brand or specialty items) or items with a lower cost such as generics. In either case, it is important to understand how these items are priced to ensure you make the proper revenues on these items.

Additionally, increasing or decreasing your COGS will impact your Gross Profit. With your inventory costs (or COGS) decreased, your Gross Profit will likely increase; conversely, when your inventory costs increase, you will decrease Gross Profit.

Proper inventory management is a key component to maintaining a realistic COGS.

Ways to improve it

Since your inventory is likely the largest expense in the pharmacy, it’s wise to explore ways to lower its cost to you. To that end, accurate inventory management is crucial – as is knowing when and how to buy product. Opportunities exist to lower your COGS. Here are some strategies to consider:

  • Understand and discuss pricing regularly with your primary and secondary suppliers to ensure your pricing is competitive.
  • Maintain proper inventory accounting principles – use just-in-time (JIT) inventory to your advantage and prevent dollars from sitting on your pharmacy shelf. Monitor your inventory turns with regards to your fast and slow moving items.
  • Ensure inventory control – put proper procedures in place to reduce product shrinkage/loss.
  • Purchase wisely – take advantage of additional incentives offered by your suppliers (examples may include: payment terms, trade shows, bulk order discounts, etc).

 

Consider these key strategies to lower your COGS! Click To Tweet

 

This post is one of a five-part series in understanding your Income Statement. The series breaks down the accounting principles of Revenue, Cost of Goods Sold, Gross Profit, Operating Expenses, and Net Profit, to help independent pharmacy owners make more informed business decisions.

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