Resource Centers:(News, information, and tools to support your practice)
November 2007
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Does it make sense to carry products?
Does it make sense to carry products?
Inventory basics can help you decide
By Brenda Stoner
Practice consultants advocate the addition of products to your revenue stream, and it certainly makes sense to your top line. But what does it do to your bottom line?
Does it make financial sense for you to carry and sell products to your patients? To answer that question, you first must have a basic understanding of the implications of carrying inventory.
INVENTORY IS CASH
Inventory is simply cash in disguise. When you purchase inventory at a wholesale price, it is similar to purchasing real estate with the hope it will appreciate and provide a profit.
When you hold inventory, you assume you will achieve a profit greater than your cost to provide it to your patients.
FIFO FOR YOU
You don’t want to hold inventory forever. Rather, you want to sell it as fast as possible. And the product you sell should be the oldest product on your shelf. Rotating product so the oldest is the first sold is practicing FIFO — an accounting acronym for “first in, first out.”
FIFO ensures perishable items (such as supplements) are sold before their expiration dates. It is also used for costing purposes.
Costing is important if a product’s pricing changes. If your cost increases on an item, but the price you charge remains consistent, you earn less profit on the newer items than the older ones. Most accountants advise using the oldest first to keep the books straight.
INVENTORY TURNS
Even if you practice FIFO selling and accounting, you don’t want inventory sitting on your shelf for a long time. If a product is not selling, it is taking shelf space from something that could be providing a profit.
To know which products are good to carry, calculate inventory turnover, or turns. This is the number of times your inventory cycles, or turns over, per year.
The accounting definition is complicated: Inventory turns = Cost of goods sold (over a given period) divided by the average inventory value (over the same period).
The easy way to measure turns is to count how many times you have cleared the shelf for a particular SKU (stock keeping unit). If you clear the shelf once a month, this is equivalent to 12 turns per year.
Increasing inventory turns reduces your holding cost. In theory, the practice spends less money on rent, selling costs, utilities, insurance, theft, and other costs of maintaining a stock of goods to be sold.
Should you carry inventory? Carrying inventory has its pros and cons. On the plus side, carrying inventory: • Ensures patients the use of products you recommend; As compelling as those arguments are, however, there are strong reasons not to carry inventory. If you do not carry inventory: • Your business is simplified; The key is to find an appropriate level of inventory for the size of your practice. In a small practice, it may be better to utilize drop-ship programs from your suppliers. This means product is shipped directly to patients from the factory, potentially generating commissions for you or the practice. |
More important is the real cost of the dollars
Reducing holding costs increases net income and profitability as long as the revenue from selling the item remains constant. Keep in mind that an excessive number of turns may also indicate you are not holding enough inventory. Holding inadequate inventory can inflate your costs to procure small orders and lead to an out-of-stock situation that causes lost sales.
The type of business determines an appropriate level of turns, though every business is different. Typically retail stores experience three to five turns; large manufacturers, six to eight turns; grocery stores, 10 to 12 turns; and gas stations with mini-marts, 30 to 40 turns.
In general, the more volatile your prices or perishable your products, the more turns you need. A good target for small- to medium-sized practices would be to try to move products at least five turns per year. This would keep products fresh and current and cash flows moving.
In a very small practice, it may be better to utilize drop-ship programs from your suppliers. This means product is shipped directly to patients from the factory. One advantage of most drop-ship programs is you can often earn a commission from the supplier on the product directly shipped to patients.
TAX IMPACT
Profits made on products also carry tax consequences as income for the practice. The amount taxed is the net profits from the profits. Net profits are determined this way:
• Calculate gross profits. Gross profits = sales – cost of products sold.
• Subtract selling expenses. Selling expenses are items such as credit card fees, labor associated with sales, commissions, and cost of stolen or lost products. Net profit = gross profit – selling expenses.
Once the net profits are calculated, apply the appropriate tax rate to find out how much you owe in taxes.
WHAT’S THE ANSWER?
Like most complicated situations, the answer to the inventory question is: “It depends.”
• Review the number of turns to determine if cash is being adequately leveraged;
• Consider patient impact and service;
• Evaluate if your staff has enough time to handle the product ordering and sales and inventory maintenance activities; and
• Review post-tax profits to make sure your bottom line is impacted appropriately.
In the end, the answer may best be decided between you and your CPA.
Click here to determine how much inventory you should hold and when you should place your inventory orders. The calculation attempts to keep your inventory level as efficient as possible, while maintaining adequate safety stock.
How much inventory? So, how do you choose the right products and the right inventory level for your practice? Here are some suggestions: |
Brenda Stoner is president of Drucker Labs, Inc., the manufacturer of intraMAX. She can be reached at 888-881-2344, by e-mail at bstoner@druckerlabs.com, or through the Web site, www.druckerlabs.com.
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