Accounting mistakes to fix now: a primer for your pharmacy
Everyone makes mistakes. Some are worse than others. But when it comes to selling your pharmacy, few are as pernicious as sloppy accounting. When prospective buyers look at your business’s financial records, you want to leave them with the impression not only that your “numbers” are solid and indicative of a healthy, profitable pharmacy, but also that you are a smart businessperson whose accounts – and word – can be trusted.
Bad accounting undermines all that, and it can spell the difference between success or failure in the sale of a pharmacy.
In recent articles, we have taken an in-depth look at some of the most common accounting gaffes we have seen over our decades of advising pharmacist-owners on selling their businesses.
For this entry, we thought a recap of those mistakes might be useful to readers. Think of it as a “Not-to-do List” for your pharmacy accounts.
No. 1: Guessing at your inventory instead of doing a physical count.
Yes, performing a physical inventory can be a real drag on your time and resources. But you have to do it. Otherwise, a buyer won’t be able to really trust your cost of goods (COG) account, impacting whatever profitability numbers you put forward. That’s a big red flag.
No. 2: Recording inventory at invoice cost rather than net cost.
If you don’t record what you paid for inventory net of commercial terms, you are overestimating its value, and a buyer will not be able to rely on working capital numbers. If your balance sheet reflects your invoice amount, you’re falsely inflating the numbers, and reliably calculating the value of generics that cycle through your inventory becomes challenging.
No. 3: Manipulating inventory count to get a “corrected” margin.
Highly questionable, and probably unethical. You are fiddling around with COG and EBITDA. Savvy buyers won’t trust it.
No. 4: Ballooning or deflating inventory to lower or raise COG.
Sometimes an owner or their accountant will manipulate inventory count to reach their target COG and, therefore, a target earnings number. Often, the justification is to ensure that earnings come in under small business tax thresholds. But the net effect on your books’ reliability is the same as No. 3 above: garbage in, garbage out.
No. 5: Recording commercial terms payments as revenue.
There are a few mistakes we often see in the accounting of commercial terms, but this is the most common. Commercial terms are not revenue and should not be recorded as such. They should be recorded as a reduction in your pharmacy’s cost of goods sold.
No. 6: Not recording pending commercial terms payments as accounts receivable.
A lot of the balance sheets we look at omit expected commercial terms payments in their accounts receivable; often, these payments are simply recorded as cash. But if pending rebates are not part of AR, then they can lead to an unreliable calculation of working capital.
No. 7: Keeping non-active assets within the business.
Pharmacist-owners typically do this because they think they are sheltering their assets from tax consequences. But holding assets not directly related to the operation of the business can have very adverse consequences when it comes time to sell:
- It puts your lifetime capital gains exemption at risk, because holding non-active assets can mean your company does not meet the criteria for a qualified small business corporation (QSBC).
- Once those non-active assets are in the business, it can be a big challenge to tax-efficiently get them out. “Asset purification” strategies are available, but they tend to be time-consuming and complex.
- It heightens liability risk. In the event of a lawsuit or company bankruptcy, non-active assets could be lost to a legal judgment or to creditors.
No. 8: “Negative” margin in dispensary records.
This most often occurs when a dispensary records multiple doses of a medication that a payor considers a single dose – inhalers are a common example. So, the dispensary is recording all these doses but the insurance company is paying for only one. This can create a negative margin in your dispensary records where your business accounts show a profit. A potential buyer won’t know exactly which numbers to trust. Regularly clearing false negative margin off the dispensary books, therefore, is a must.
No. 9: Not dating future accounts payable.
If you only record what your business owes in the next payment cycle as accounts payable, then you’re ignoring the future due. Payments yet to be made that you know you will have to make need to be recorded and dated in your accounts payable.
No. 10: Not recording accounts receivable or accounts payable at all.
Yes, this actually happens. When it does, a potential buyer (or business valuator) has practically nothing to rely on when estimating what’s going in and out of the business, and any estimated value will never be better than a guess.
No. 11: Mis-recording dispensary relief expenses.
Sometimes a pharmacist-owner will record expenses for a relief pharmacist under the line for accounting and professional expenses. That line, though, is for fees paid to accountants, lawyers, business consultants and the like – not for staff replacements. Those are staff expenses, and not recording them as such artificially lowers your staffing costs, which can throw a wrench into margin calculations.
12. Including capital costs in your cost of goods.
This balloons your COG, lowers EBITDA and ultimately your store’s valuation. Capital expenses must be recorded as, well, capital expenses.
13. Putting capital costs in your profit-and-loss statement.
This creates the same problem as Error No. 12: it lowers EBITDA and, ultimately, store valuation.
14. Paper ledgers.
The 1970s called – they want their ledger books back. But seriously, you might be surprised at how many pharmacies still rely on paper and ink for their accounting. Software is just plain better. It allows for more precision in accounts, and it lets other people – like potential buyers – analyze financial information accurately and efficiently. Paper ledgers have been obsolete for about 40 years. If you’re still using them, it’s time to join the 21st century, or at least the late 20th century.
So, there they are: the Hateful 14. The good news is that most, if not all, of these mistakes are easily avoidable or – if you are currently making them – fixable. Yet remember: when you are thinking of selling your pharmacy, time is not your friend when it comes to getting your books in order.
So, take a good, hard look at your bookkeeping practices and talk them over with your accountant to ensure they are putting you and your business in the best position to sell. We would be happy to help interpret our list with you and your professional advisors. Furthermore, doing it now will help maximize the value of your business – and could well save you a multitude of headaches in the future.
