Veterinary Inventory Management - why inventory management is important

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The pharmacy and its inventory are vital for any veterinary practice. They represent a medical toolbox for the practitioner to treat patients, a significant source of revenue for the owner, and a substantial investment of time and money for the business.

This article will address the importance of pharmacy inventory to the veterinary practice. To do so, we will explore some of the challenges that a practice faces in regards to inventory management and then exhibit advantageous of good inventory management.

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Veterinary Inventory Management - why inventory management is important

  1. 1. Doctor, we have an inventory problem. How can we have an inventory problem? If we are running low you just write it on the list, order it, and put it on the shelf. No problemThe pharmacy and its inventory are vital for any veterinary practice. They represent amedical toolbox for the practitioner to treat patients, a significant source of revenue forthe owner, and a substantial investment of time and money for the business.Lets explore some of the challenges that a practice faces in regards to inventorymanagement and then exhibit advantageous of good inventory management.LocationMany veterinary practices organize their inventory and tools around cellular workflow.The idea is to have what you need, where you need it, at the time it is needed. This iswonderful for workflow but tends to decentralize inventory. Inventory supplies arescattered throughout the practice: paracitisides are located near the front desk, in thepharmacy, and sometimes a back stock located somewhere else. Surgical supplies can belocated in the surgical suite but we might also have suture stock in an emergency kit, inthe dental suite, and in the exam room. Essentially the convenience of cellular workflowadds a layer of complexity to tracking and monitoring inventory. The goal of keepinginventory close-by is to enable the provider to be efficient and effective without having tosearch for supplies. But inevitably it results in a cumbersome inventory system thatneeds to be actively managed.Products stored in multiple locations will get re-stocked at different time intervals. Eachtime inventory is received and stocked, special considerations should be made in regardsto expiration dates. Many times inventory is received and stocked in the location where itis needed most. The inventory just received will likely be the inventory with the longestshelf life. This leaves the less utilized inventory locations with potentially expiring stock.In the example below, the reception and pharmacy stock gets utilized with far morefrequency. The back stock is right next to the receiving door. Theoretically the stockshould be received and stocked in the back stock location. However, in the rush of a
  2. 2. busy day, some of the received product gets moved up front and the danger of expiringinventory in other locations of the practice becomes a real possibility. Pharmacy stock Back stock Reception stockPeopleThese mistakes happen even in the best scenarios but a dedicated person to manageinventory is the best way to limit these types of mistakes. Very few practices have oneperson who oversees inventory for the organization. Even fewer have a definedprocedure for how inventory is requested, requisitioned, received, stocked, andmonitored. The business of the veterinary pharmacy has not advanced to the point ofbuying products based upon projected needs identified through historical use. Instead, ateam member is appointed to take care of inventory and they purchase based uponexperience and a “need to order” list.The "need to order" list is posted somewhere in the practice where almost everyone canadd to the list. In many cases, the actual order placed is generated from the “need toorder” list without regard to usage patterns. To further compound the problem, someindividuals within the practice may hide back stock so the practice doesn’t completelyrun out of a certain product. Naturally this adds yet another inventory location to themix. The problem in this case is not solely location based, it is also people based.A technician will “hide” supplies so the veterinarian they work with doesn’t run out oftheir favorite product. This well meaning individual will keep a secret stash as anemergency stock. This good intention adds to the complexity of tracking inventorywithin the practice.
  3. 3. Pharmacy stock Back stock Reception stock “hidden” stockIdeally, those who order inventory should receive and stock inventory. This is not alwaysthe case. In our example above, we would potentially not need to order if “hidden” stockwas added to inventory. Even with an inventory manager, inventory can be mismanagedby the lack of a coordinated and understood inventory plan. Very often the stock is puton the shelves by whoever is available to do it that day. Additionally the inventory isstocked where it is most needed without considering expiration dates.Of course this is a worst case scenario. And most practices do not let the problembecome that pronounced. Instead these problems rear their heads in various ways. Whenthis happens often enough, the owner usually decides to have someone in the practice“keep an eye” on inventory.TrainingMany times an individual within the practice rises to a position of relative stature due totheir performance as a technician or receptionist. This person is given the addedauthority of handling inventory. While this individual might be knowledgeableregarding the basic inventory items, they very rarely receive any formal training oninventory management. These individuals have to learn the intricacies of more complexinventory items like anesthesia and equipment while they are on the job. And, mostoften, they have a core position within the organization for which they are alsoresponsible. This results in the newly appointed inventory manager learning just enoughto keep inventory on the shelves with the minimal amount of interruption to both their"normal job" and inventory supply. The likely result is more product stocked on theshelves to simplify inventory management.The new inventory manager is not at the clinic at all times. Therefore, inventory is notproperly requested, requisitioned, received, stocked, and monitored without the inventorymanager present. Unless, of course, there are good procedures and protocols written.However, because this individual has other core responsibilities, this documentation and
  4. 4. strategy rarely gets developed. And, as previously mentioned, the new inventorymanager might not know where to begin creating those policies and procedures withoutsome level of formalized inventory management training.Historically, veterinary and technician schools do not offer formalized training systemsfor inventory management in their curriculum. While more schools are starting to offerthese classes that fact remains that the staff within a practice today have never had anyexposure to formal inventory management. As such, a new inventory manager wouldneed to train the remaining staff on basic principles of managing inventory.VeterinariansVeterinarians, like their human doctor counterpart, have products they employ fordifferent problems or procedures. Those product choices vary from practitioner topractitioner. One veterinarian might like a more pliable suture for one procedure but notfor all. One veterinarian prefers one flea control over another. And so on. As thenumber of veterinarians in the practice increases the more product preferences becomesomething that needs to be monitored, managed, and discussed. The inventory managerneeds to learn what each veterinarian prefers and monitor those preferences across alandscape of business seasonality. The practices without a focused inventory person havevery little chance of effectively keeping a handle on these complexities.The alternative, of course, is for veterinarians to have an inventory rationalization processwhereby products are chosen and standardized. This represents a significant challengeand opportunity for the veterinary practice. The challenge is to provide enough flexibilityand efficacy within the product choices so the veterinarian can practice medicinecomfortably and confidently. The opportunity lies in streamlined inventory categories(NSAIDS, Parasiticides, etc) and less products for the staff to learn.NomenclaturePractitioners refer to products by different names: brand names, generic names, jargon,what they used to use, etc. This requires the inventory manager to have an overallknowledge of the various product names and indications. Also, each product might havedifferent package sizes and dosage formulations. The inventory manager will have tolearn the nomenclature used by each practitioner, by each vendor, and by the staff.Practices that have performed an inventory rationalization process will limit the impact ofdifferent nomenclatures.Practice management systemsPractices struggle to trust their practice management software inventory system. Thecurrent practice management systems have adequate inventory management systems yetmost practices do not use them effectively. Little mistakes can add up to huge problemsif the inventory manager does not fully understand the software. When items getrefunded, how does the practice management software work? Does it put the productback into inventory? Has the inventory manager received a case quantity of one, yet isselling individual doses? How does the purchase order system handle backorders?
  5. 5. For practices who utilize the inventory management module of the system, it is stillessential to perform a physical count. Verifying the inventory on hand on a monthlybasis is imperative to accurate counts. Practices that rely on counts from their softwarecan easily identify when it is time to order without looking at each inventory location orrelying on a “need to order” list as long as inventory counts have been periodicallyperformed. This assumes the practice has eliminated the need and practice of having“hidden” stock. When a physical count is completed the practice must be countingeverything that is in the practice. If those counting parasiticides didn’t know there was ahidden stash then the inventory manager has to assume the computer is wrong. This is avery common reconciliation problem and has the unintended consequence of reinforcinga mistrust of the practice management inventory system.While practice management systems are adequate for inventory management, they alllack the sophistication to automatically ascertain shipping times when creating suggestedpurchase orders. Those calculations must be performed and factored into the reorderquantities. Most systems do not have flexible pricing models. And lastly, they all lackthe sophisticated inventory reporting mechanisms that other industries have utilized fordecades. The concept of “demand forecasting”1 has long been used in the automotiveand manufacturing industries but has yet to be built into veterinary practice managementsystemsOne important fact not to be missed is many veterinary businesses lack knowledge oftheir inventory on hand value. This is a once per year calculation conducted inpreparation for taxes. The reality is the veterinary practice can see how much they havepurchased and how much they have sold but have not properly invested time to set up theinventory module so that they can get a proper on-hand quantity and value. As such, thetrue financial picture of the practice is devoid of cost of goods sold (COGS) until the endof each fiscal year when a physical count of inventory is conducted. The on-handinventory value is also important for calculating the practices inventory turn rate.Turn OverHistorically practices have not invested significant time and energy into analyzing theirturn rates because they have not had accurate numbers from which to begin. The formulais quite simple. Divide the annual usage by the current on hand inventory to derive thenumber of times the inventory turns over. 7.5 turns per year 2,000 15,000 yearlyGenerally speaking, this analysis should be done by therapeutic category: biologicals,parasiticides, antibiotics, controlled drugs, etc. In this way, the inventory manager cansystematize how each category should be handled. The next step is to calculate the1 George, L. Michael. Lean Six Sigma: Combining Six Sigma Quality with Lean Speed, 1st ed. McGrawHill2002
  6. 6. average number of days the product sits on the shelf. For that calculation, the inventorymanager should divide the number of days in a year (365) by the number of turns peryear. Using our above example: 48.7 days of supply 7.5 365 daysProfit and revenuePractice owners have a number of important decisions to make regarding inventorymanagement. Inventory accounts for a major portion of the veterinary business from arevenue and an expense perspective yet very few practices dedicate the necessaryresources to managing it effectively. Thirty nine percent of a practices’ gross revenuecomes from product related sales.2 Gross Revenue Product Sales Service and other salesAs such, the inventory manager is responsible for a large percentage of practice revenueand is a vital piece of the opportunity puzzle. A practice that is out of a certain inventoryitem for three days will directly lose gross revenue on the missed sale of that item. Everymissed sale is a missed profit opportunity.From an expense perspective, product related expenses represent 17.4% of grossrevenue.3 Inventory expenditures are the single largest outside expense for a practice.Interestingly, many practices spend very little effort managing inventory in asystematized and documented fashion. Instead, for many, the goal has been to simplylower those expenditures. In theory that is a good goal but not at the cost of missing2 Wutchiett Tublin and Assoc. Veterinary Economics: Benchmarks 2009. C 20103 Wutchiett Tublin and Assoc. Veterinary Economics: Benchmarks 2009. C 2010
  7. 7. opportunities vital to the 39% of gross revenue that most practices enjoy from carryinginventory.The inventory manager is also responsible for profitability in a very real way. Suppliersmay update pricing throughout the year. The practice management software is designedto markup a product based upon its cost. If the inventory manager does not enter the newcost into the system the practice is instantly giving up a percentage of profits. Forexample, the supplier charges $10 for product x. If the supplier raises the cost to $11 thatcost must be updated in the system. This is the direct cost associated with that inventoryitem. However, there are other costs, namely indirect costs, which must be taken intoconsideration. Depending on the pricing strategy of the practice, the true cost of the itemsold may not be accurately assessed.The true cost of inventory encompasses several areas. The easiest cost to recognize is thedirect or capital costs associated with inventory mainly because the costs are identifiablein a businesses accounts payables4. There are, however, a number of indirect costsassociated with inventory that should be recognized. Below is a description of direct andindirect costs: A. Capital Costs (direct cost): This is the direct cost of financing the inventory. It also reflects an opportunity cost of tying up capital in the form of inventory rather than using the capital for other purposes. This figure should include any shipping charges or sales tax charges. B. Inventory Service Costs (indirect): These are typically in the form of taxes and insurance. Taxes would be a short term variable cost that goes up and down depending on inventory levels. Insurance however, (property, fire, theft, etc) does not typically vary and, as such, is a fixed overhead cost C. Storage Space Costs (indirect): This is also a fixed overhead cost that should be expressed as an operating rate divided by total square footage in the practice D. Inventory Risk Costs (indirect): There are risks associated with inventory. Products could get damaged or even become obsolete. Also, the cost of moving inventory from one location to another is an example of a risk related cost.True costing is not entered into most systems and, as such, automatic markup processesbuilt into the practice management software will yield a profit far less than anticipated.While many practices use a dispensing fee to cover the indirect costs of inventory, manypractices miss the direct costs associated with sales tax and shipping fees because they donot apportion those fees to the individual line item from the vendor invoice.Cash flowThe inventory manager is also responsible for cash flow. As discussed earlier, the capitalcosts of inventory also represent cash that is not available to be spent or invested in otherthings. This is an opportunity cost. That money could be utilized for other investmentsbut could also be completely liquid to improve cash flow.4 George, L. Michael. Lean Six Sigma: Combining Six Sigma Quality with Lean Speed, 1st ed. McGrawHill2002
  8. 8. Another key area of improving cash flow is limiting the amount of time between when apractice must pay the supplier and when the practice sells the product. A cash gap refersto the time interval between when a product is paid for and when it is sold. See theexample below Cash gapOrder is placed Shipping Product stocked Supplier is paid Product sold Product on shelfFollow the above model from left to right. You will see that more inventory is sitting onthe shelf than necessary. There are only two ways to improve the cash gap: negotiate alonger billing period with a vendor or increase the number of stock turns. This assumesthat all customers visiting the practice pay their bill at the time of service. If a customerdoes not pay their bill this, of course, increases the cash gap.Safety and “in transit” stockThe inventory manager must ensure that drugs and suppliers are available. Toward thatend, there might be some inventory that must always be on the shelf. To account for thisthe manager must have some safety stock in case of supplier back orders. If the supplierback orders an item and the practice has no safety stock then there is a product gap. Theinventory manager must also take into consideration the time it takes to ship the productfrom the vendor. If the practice runs out of a product due to a backorder from a vendor orthey are simply waiting on the next shipment, it represents lost revenue to the business.In this case, we have a product gap. See example below Product gapProduct sold Order is placed Product stocked Backorder ShippingPromotional buyingSuppliers to the industry occasionally offer a promotional price and program in exchangefor purchasing a larger volume of product. This strategy can put an enormous cashburden on the practice but offers the inventory manager a supply of stock that does notactively need to be ordered. Additionally, the practice may focus their dispensingenergies on that supply of stock which creates an economy of scale. Suppliers givediscounts off the purchase price which, in the long run, will net more revenue. Manysuppliers also offer delayed billing in an effort to smooth out the cash flow problemsvolume buying can create.
  9. 9. Buying RestrictionsIn some instances a product cannot be purchased in a quantity that is ideal to the practiceusage patterns. A buying restriction might include a minimum order, case quantity,dosage and formulation limitations, etc. Buying restrictions exist in almost everyindustry. The goal for the inventory manager is to purchase as little as possible in lowvolume stock or inventory that does not move quickly. This presents a problem when acase quantity is the only way to purchase. Those practices with a proper inventoryrationalization process in place might find they can limit the amount of products in anyone category which will make case quantity purchase far more palatable.The ideal cash flow scenarioThe cash gap is money that cannot be spent and is technically at risk. Every day themoney sits on the shelf it actually becomes worth less. The goal of the inventorymanager is to limit or completely eliminate the cash gap by purchasing in smallerquantities that reflect the projected demand for that product. Order is placed ShippingOrder is placed Shipping Product stocked Product sold Supplier is paid Product stocked Product on shelfIn the illustration above, we have product sold prior to the supplier’s billing due date.After the product is sold, or we reach our reorder point, the order is placed in enoughtime to ship and restock the product. This is the ideal scenario as inventory purchasingwill have the least amount of impact to cash flow.As the practice nears its reorder point, the inventory on the shelf should be the inventorywith the longest shelf life. And this product should be sold before any of the new productis sold. This is a concept known as FIFO (first in, first out). The method simply statesthe first items placed in inventory are the first items sold from inventory.Summary:Businesses must pay attention to inventory. Even if the approach towards inventory isborn from necessity and/or convenience, the business has an inventory strategy. Theextent to which the strategy is thought out and purposeful will be the extent to whichinventory becomes a business advantage. Without a focused plan, inventory will managethe business. With a focused plan, the business will manage inventory. The cleardemarcation point is stepping away from convenience and necessity towards business
  10. 10. intent. When the business intends to use inventory as a tool and financial vehicle, thebusiness will reap the rewards of that tool.

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