In the veterinary industry, leaders aim for a Cost of Goods Sold lower than 24% of Gross Revenue. If yours is higher, your issue is likely one or more of these 23 reasons.
While this list is likely a fast track to your issue, you’ll be better off in the long run understanding how your practice management software manages inventory and how to work with it correctly to achieve optimized results. Use the following link for a thorough tutorial in veterinary inventory management.https://www.bashhalow.com/monitoring-veterinary-financial-health/
Where to Look
High COGS can usually be traced back to four reasons:
- Pricing and revenue capture
- Purchasing practices
- Inventory use and waste
- Accounting and ways inventory items are organized in the accounting and practice management software.
Each is described in more detail below.
Veterinary Pricing & Revenue Capture
- Low Markups: Product markups are insufficient to generate an appropriate margin. Use benchmark direct-cost ratios to determine the necessary markup. The formula for converting a direct-cost ratio to markup is:
Markup % = (1 − Direct Cost Ratio) ÷ Direct Cost Ratio
For example, a 25% direct-cost ratio requires:
(1 − .25) ÷ .25 = 300% markup
Meaning a product costing $10 sells for $40.
- Low Service Fees: Service prices don’t adequately cover the cost of the goods required to deliver them. In other words, your COGS is high by industry standards because your service prices are low by industry standards. As a first step, calculate service category revenue-to-gross revenue ratios to determine if your service prices are too low.
- Markup Confusion: Failure to understand how the software calculates markup or the difference between markup and margin. Remember that the markup number will always be higher than the margin number it generates. For example, if you want to generate a 20% margin on a service that costs $100, the markup is not 20%. The formula for margin is:
Margin = (Price − Cost) ÷ Price
0.20 = (P − 100) ÷ P
0.20P = P − 100
0.80P = 100
P = $125
Therefore, you need to charge $125, which represents a 25% markup on your $100 cost and produces a 20% margin.
- Missed Charges: Products are used or dispensed but never charged to the client.
- Excessive Discounts or Giveaways: Senior, military, new-client, rescue, professional-courtesy, and other discounts erode margins. Always use a programmed discount code so discounts can be tracked by employee, category, and amount. Instruct team members to never simply change the price of an item. Instead, invoice the item at its full price and enter the discount as a separate line item. For example, to discount a $100 CBC by 25%: CBC $100; DISCOUNT −$25. This preserves the true value of the service while making the discount visible and trackable.
- Employee Discounts: Products are sold excessively to employees at or below cost.
Veterinary Purchasing
- High Vendor Pricing: High acquisition costs combined with reluctance to apply appropriate markups for fear clients won’t purchase. This happens frequently with reference lab costs. You have failed to negotiate volume discounts or bundle prices for your lab tests. It may also be that you have negotiated lower prices, but team members are requisitioning the higher priced lab service. For example, let’s say that you have a bundled wellness lab test that includes a parasite test. Team members requisition the tests a la carte as opposed to requisition the bundle.
- Misusing Wellness Profiles: Discounted wellness profiles are typically offered by laboratories to encourage preventive screening in healthy patients. When hospital policy calls for higher-priced à la carte testing for sick patients, team members may inadvertently select the discounted wellness code instead. For example, a Senior Profile may contain the same tests as a Chem 25 but carry a lower laboratory cost because it is intended for wellness screening. Using the Senior Profile for a sick patient instead of the Chem 25 reduces the hospital’s intended margin.
- Product Redundancy: Multiple versions of essentially the same drug or product are stocked when fewer would suffice. Essentially, your baseline of inventory is always on the high side because you are stocking double or triple what it takes to do your work.
- Vendor Negotiation: Working with multiple vendors can work against the best pricing deals. Work with one company to provide most of your supplies and then negotiate volume discounts.
- Buying Opportunities: You are not taking advantage of discounts, rebates, or buying-group prices when you can, but remember that purchases that remain in inventory at the end of the accounting period can inflate COGS if inventory changes aren’t properly accounted for. For example, there is a year end sale of flea medication and you stock up. If you close the accounting period by December 31st and most of the flea medication remains unsold, your COGS will be high.
Veterinary Inventory Use & Waste
- Inventory Shrinkage: Products expire, are damaged, stolen, lost, wasted, or otherwise disappear without generating revenue.
- In-House Use: Food and medical supplies used for hospitalized patients, shelter work, or other in-house purposes that aren’t charged or accounted for.
- Failed Tests: In house blood tests that fail are never accounted for. For example you try to run an in house CBC. You use 3 rotors, but only one returns results, yet the cost of the two failed rotors is never accounted for.
- Free Products: Hospital-purchased products are given away as samples or promotions without accounting for their cost.
Veterinary Accounting & Inventory Management
- Over-Ordering: More inventory is purchased than can reasonably be sold or used within the accounting period.
- Service Consumables: Swabs, alcohol, paper products, and other supplies aren’t adequately incorporated into service pricing. For example, a dog pees on the floor, instead of using mop to clean it up, someone grabs an entire roll of paper towels.
- Misclassification: Expenses that veterinary benchmarks place elsewhere are incorrectly categorized as COGS. For example, your accountant has put the cost of relief veterinarians in COGS. For a proper list of how to categorize all of your products and services in both your accounting and practice management software refer to the AAHA VMG Chart of Accounts.
- Unapplied Rebates: Manufacturer rebates and purchasing discounts aren’t credited back against COGS.
- Unapplied Credits: Credits for returned inventory aren’t properly applied back against COGS OR inventory items that are eligible for return are not sent back to the vendor for credit.
- Failure to receive inventory through the software: Inventory isn’t received through the software, consequently acquisition-cost increases aren’t identified and prices aren’t adjusted.
- Transfer Errors: Inventory moves between locations without the associated cost moving with it, distorting location-level COGS.
- Free Goods: Manufacturer or vendor free goods, especially giveaways, are not properly entered into the software making it appear that the goods were purchased at their full value.