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07/13/2022

Benchmarking your pharmacy's inventory turnover

Let’s face it: inventory can be a pain to manage. But handling inventory effectively is vital to the success of any retail operation. Doing it right means achieving a delicate balance.

In our experience, pharmacist-owners are generally much more attuned to what’s going on behind the dispensary counter than what’s happening in the front of their shop.

Maybe that’s not surprising, given that delivering healthcare is what pharmacists are trained to do. But then one day, maybe, they’ll be walking out of their pharmacy at the end of a long shift and finally notice the lawn-dart set (or whatever) they’ve been passing by every night for practically ages. And they’ll think to themselves, “I wonder how long that has been sitting there?”

Let’s face it: inventory can be a pain to manage. But handling inventory effectively is vital to the success of any retail operation. Doing it right means achieving a delicate balance. If you do not have enough stock to meet demand, you run the risk not only of leaving revenue on the table, but also of alienating your customers. On the other hand, if you have too much inventory, storing and counting it can be an expensive drag on your cash flow; in the dispensary, it can mean spending unprofitable time sorting through expired drugs. Even worse, every unwanted item that’s just taking up space on your shelves means you have fewer items that customers might actually want to buy. Excess inventory comes with a clear opportunity cost.

So, how do you get a handle on inventory? As with other aspects of running a pharmacy business, measuring and then benchmarking are the keys. The good news is, determining how effectively you are managing your store’s inventory is simple. The not-so-good news? Improving your inventory management can require making some difficult decisions.

The benchmark we most often use in our work with pharmacist-owners is the inventory turnover ratio, or ITR. Basically, you find the average of inventory value at the start and the end of the year, and then divide that into the cost of goods sold in the year. As a formula, it looks like this:

ITR = Cost of Goods Sold ($)/Average Inventory ($)

As an example, let’s say your total cost of goods sold last year was $5 million, your inventory was $400,000 at the start of the year and $600,000 at the end. The ITR for your pharmacy is 10, meaning inventory turns over 10 times a year, or once about every five weeks.

It’s advisable to calculate ITR for the prescription dispensary and the front-of-store separately, since this will give more insight into how the two business lines are performing. Also, turnover in the dispensary is usually higher than front-of-store, so calculating for each operation ensures you will be comparing apples to apples.

The industry benchmark ITR for dispensary is 12, meaning that inventory turns over every month. That is the sweet spot, in our view, but not every pharmacy hits it. On the other hand, we sometimes see ITRs of 24, a number which looks great but also runs the risk of the pharmacy ending up “owing” the patient. If Max (not his real name) goes to get Viagra and your pharmacy is all out, you’ve probably lost a patient, and your great-looking inventory ratio won’t matter very much.

Still, low ITRs in dispensary are probably the more common problem. One way to get a higher turnover is to adopt an appointment-based model. (We discussed ABMs more fully in a previous article). Knowing when a patient is showing up for his medication can help you make sure you have it in stock when – but not before – you need it. A helpful addition is to pair your ABM with medication synchronization, in which the pharmacist synchronizes prescriptions for patients with multiple medications so they can pick them all up in the same visit.

For front-of-store, the highest ITR we have ever seen is 5. In other words, this pharmacy managed to turn over its front-of-store stock every 2.4 months. That is remarkable – and raises the possibility that this pharmacy was understocked; however, it was simply a large, well run front-of-shop. Conversely, we have seen some with an ITR of 0.5, which means it takes two years (!) to sell through. In general, we think a reasonable benchmark ITR is between 2 and 4, or turnover every 3 to 6 months for front store. Different items, of course, will move at different rates: gifts will sell only at a half to two times in the year, for instance, while confectionery will turn over more frequently.

And what do you do if your front-of-store turnover is low?

Here, you have to be cruel to be kind. Identify all the stock that has not sold in five years (yes, we have seen this, and worse) and get rid of it – it’s not doing you any favours. Then do the same with any items that have been sitting for four years, and then keep going. When you get down to two-year-old stock, you will have to exercise some judgment. Maybe you do want to hold on to that invalid ring cushion because someone might need it someday, and anyway it doesn’t expire. But when the product is so shelf-worn, just throw it out – it is tarnishing the image of your business.

In addition to the use of ITRs, using Gross Margin Return on Investment, or GMROI, can help you determine whether you are making a profit on your inventory. Usually only used for the front store items, it can show you how much you make on every dollar you invest in inventory. This ratio can be applied to your entire front inventory, but it is most valuable when calculated by department, fine line, or SKU. It can be a bit cumbersome to use in the beginning, but an effective ratio to use when tackling an inventory problem. And a lot of POS systems can calculate this for you.

One more piece of advice: if you have a lot of old front-of-store stuff to move, use the clearance bin judiciously. You don’t want it to be fuller than your shelves!

For a more thorough review, see Pharmacy Management in Canada Chapter 16 – Financial Ratios: Putting the Numbers to Work, page 150, Inventory Management.

 

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