Inventory Management Elise M. Lacher, CPA VHMA 2009 Annual Meeting and Conference Doubletree Hotel Portland Lloyd Center, Portland, OR Gold Sponsor Setting the Stage What are the two largest costs that we face in our hospitals? (I used to say the second largest cost, but with some of the inventory counts that I have seen, I have changed the phrasing.) Today we are going to be spending time talking about inventory management for two reasons it has a major impact on the bottom line when we get it right and, to be honest, it is much easier to work on inventory than on the many issues that we face with managing our human resources. Let s be sure we understand what we are talking about. What is inventory? How many of you have access to the financial statements for your Practice? If you do, where do you find inventory? There are actually two components to inventory inventory on the balance sheet - that is the stuff that is sitting on shelves, in drawers, in cabinets. It is the equivalent of dollar bills sitting there waiting to be put to work. The other part of inventory is on the income statement. Ideally, inventory on your income statement is grouped together in a section called cost of goods sold. This is inventory that has been put to work vaccines given to pets, bandage materials used to wrap wounds, drugs prescribed for various ailments. In other words, inventory on the income statement is stuff that you have used in the exam room, the surgery suite or the treatment area to practice the high quality medical care that you say you provide. If you are going to take on inventory management in your practice, there is something you need to be totally aware of generally in most practices, getting inventory really managed, takes a good year. Be prepared to invest the time and energy to make it happen. Be prepared also to understand that as you get inventory under control, your financial statements will very likely take a hit. As you clean up and write off inventory that you have been accumulating incorrectly, it will have a negative impact on the profitability of your financial statements. But like anything else, no pain, no gain. You have to get it done and over with so you can get on with doing an even better job with managing your practice. It is also critical to the success of your undertaking that you have the commitment from your owner, buy in from your doctors and ownership from your team. If you don t, you need to either not start down the path or fix where you are weak before you do this. How do you gain commitment from your owner? Show them this Revenue $1,000,000 Revenue $1,000,000 Cost of Goods Sold 300,000 (30%) Cost of Goods Sold 220,000 (22%) Gross Profit 700,000 Gross Profit 780,000 By bringing your Cost of Goods Sold down 8%, you bring $80,000 more to the table to pay bills, increase salaries, purchase equipment, etc. etc. etc. Generally, when owners see that they can have more money in 1
their checkbook, real money, not just a pittance, they become committed to giving you the support you need to make it happen. By the way, you can t just move costs from the income statement to the balance sheet to improve your numbers. There are some pretty well established numbers to provide you guidance to figure out what the correct amount of inventory you should have sitting on your shelves. Generally, you want about $15,000 of inventory on your shelves for each full-time equivalent doctor. Now, in a one-doctor practice that number is probably a bit low, however, as you get to two or more, $15,000 per doctor works out pretty well. The other way to tell if you have the appropriate inventory on your shelves, is to calculate your inventory turns. Basically what this means is to take your average inventory (your count at the beginning of the year and the end of the year and divide by two, if you count your inventory each year, or what you think you have on hand most of the time) and divide it into your total purchases for the year. Generally this number should be greater than 10. This means that you are turning your inventory, or selling through the things on your shelves, ten or more times a year. Now some things will be turns many more times than that and some bottles of stuff you will only use one a year, but on average, your total inventory count will turn greater than ten times. Getting your doctors to buy into managing inventory will have to come from the top. Once your owners are committed, they will bring the doctors on board. Depending on the philosophy of the hospital, there could be financial incentives given to the doctors to achieve goals. This can happen despite the various compensation methods that are used for paying veterinarians. Ownership by team members may take more work. Part of the problem I have seen in practices over the years is that the workload tends to be concentrated in one unlucky person. This has either been the last person hired who barely can count to ten, or a technician who is put in the role because she knows products and she can do it. No thought given to what this might do to her other responsibilities, or training in what inventory management means or what personality traits tend to lend themselves to this type role. What I find is that in most hospitals, inventory management is too big an assignment for one person. Dividing up the task but having one person with overall responsibility tends to work much better. We will talk about the details of how this is accomplished in the next section. But spreading the task, setting goals and then sharing the rewards has worked very well in many of the hospitals in which we have implemented inventory management. We have set goals and then shared with the entire team monetary rewards for achieving those goals. We can talk for hours about how to share the rewards and if we have time we will talk about some options. For now, however, we will increase ownership by the team, if they are motivated to do so by keeping them in the loop, giving them the training and sharing the spoils with them. One of the first things we want to do with getting our team in place to get inventory managed, is to find the right person to be the inventory manager. How do we do that? We write a Job Agreement (or job description) for the Inventory Manager position. Isn t that how we begin to fill any position? Then look internally to see if you have anyone on staff who fits the position and would like to take on the duties? If not, we need to find one. Remember, this person isn t going to do it all him/herself. This is the inventory manager who leads the team in managing the inventory component of the overall hospital management. Inventory Reports Do you know how to use the inventory module on your practice management software? If you do know how to use them, do you or anyone ever read the reports? I will tell you that relying totally on your practice management software is dooming your management to failure. Even in practices with Pixel systems and central pharmacies under lock and key, human input has to be part of the equation. Until we get to bar coding, scanning, and point of sale inputting, our computers are simply not sophisticated 2
enough for us to rely on them to manage our inventory. When I walk into a practice and ask for inventory reports, I can tell you that when I am handed 200 pages of information, I know we are in trouble. Look at your reports. I have seen inventory totals of over $300,000. Yup, that looks about right. The inventory manager was used to working in a retail environment and $300,000 of inventory in her previous experience was a good number. Inventory total of $8,000 isn t right either. Well, you said that you didn t want a lot on the shelves, so less must be better. Not exactly. Minus 3332 Zeniquin 100 mg tablets is an impossible number to have. 8000 doses of brown Sentinel and 4 doses of Yellow Sentinel says that we have a problem. When you look at your cost of goods sold section on your income statement and see that it needs help, typically we look at revenue issues, missed charges or things walking out the back door, i.e., team members helping themselves. If information isn t being put into the computer correctly, i.e., a client is given a box of Brown Sentinel but the information is put into the computer for a box of Yellow Sentinel, the numbers are off because of an input error. Looking at the reports on a regular basis can spot process problems that can direct us to training or efficiency or reworking checkout protocols or??? You have to know the problem to be able to work on solutions. So the one of the first things that needs to be done, is that the person responsible for inventory needs to look at the report and fix any obvious problems with negative amounts, misspellings of products that result in many entries for the same product, inventory that is not carried, etc. etc. As the inventory manager is getting the reports straightened out, we are also going to put the doctors to work. Doctor s Tasks While the practice manager and inventory manager are working on getting the reporting straightened out and any training needed on the practice management software undertaken, the doctors need to take on the task of reviewing the inventory currently on hand in the hospital, at least what is listed as being on hand, and make some decisions. Generally, I find that having the practice manager and/or inventory manager in these meetings works out well, but that is up to you. It is the doctors job to first of all agree on what the hospital is going to have on hand. We are all in agreement that stocking personal formularies for each of the doctors is expensive and impractical. But many hospitals do it. Now is the time for them to get together and come into agreement with what flea preventatives, what heart worm preventative, which shampoos, which pain medications, which antibiotics, etc. the hospital is going to stock. These are decisions that only the doctors can and should make. It is the practice manager s role to keep the discussion on target and point out pros and cons from an inventory management perspective on decisions that they make. After the doctors agree on what the hospital is going to stock, they need to go through and rank the inventory on a scale of AA, A, B, C, D. What this means is that every product is given a code so that the staff knows that the hospital simply can never run out of a AA product, Flea and Tick preventatives, certain vaccines, for example, and which products, your D products, that the hospital could run out of, may not carry, i.e., generally scripts them out, Lactulose and some of the generic antibiotics might fit here. Recognize that this is a work in progress rankings may change, but we need to start somewhere. At this point, the doctors are off the hook for a bit, while the Practice Manager, Inventory and Team members do their thing. 3
Team Member Tasks The practice manager and inventory manager, armed with a more correct inventory report from the computer and the inventory ranking from the doctors, need to move into action. As I mentioned, this is not a one person show. So, one of the first things that we do in our hospitals is divide the hospitals into zones and find a person in each zone who is interested in become the Inventory Facilitator for that area. The logical zones we have found are Surgery, Treatment, Kennel (if appropriate), Exam rooms, Pharmacy/Lab, Food and Retail. But however you want to divide up your hospital works. Using the inventory reports from the computer we divide up the reports among the zone facilitators and have them count the inventory in their areas. The reports may need some modification. Needles or four by fours, or syringes, or stuff may be in more than one area. What we are looking for is what is in each of the zones. Additionally, as the teams are counting the inventory in their areas, I recommend that they go through and label the areas in their zones with an identification number and relist the inventory on their lists by the location within their zone. This will help in training, stocking and general efficiency in the hospital work flow. Now we are going to get a bit tricky. Based on the ranking of the items and the usage, the management team and doctors need to establish reorder points. Reorder points will depend on the ranking, usage and order quantity, meaning boxes of 10 or trays of 25 etc. Again, reorder points is a work in process and will be modified as the year progresses. Reorder points may change also depending on the time of the year, medical outbreaks, etc. We will never be removing the human thought process from inventory management. Now on a weekly basis, the zone facilitators will cycle count the inventory items under their supervision. Based on the order day for the inventory manager, the timing of these counts needs to be established. At first, everything is counted each week. What are we trying to accomplish with this frequent counting? We are looking for holes in the system. The facilitator counts and turns in the sheet to the manager who compares the count to what the inventory program is saying we have on hand. Glaring errors, meaning off by more than 2%, need to be tracked down while things are fresh in your mind. If there are really big problems, those items may be counted more frequently, even daily. Breaking up the counting into zones reduces the workload on any one person and it becomes a much more doable task. As the holes are fixed in the processes and the counts become more accurate, the frequency of the counting of especially the lower ranked items can become less often. AA and A items are counted every week, B items at least monthly, as long as there are no problems. With good systems in place and training given, and the team kept aware of how their work is impacting the financial well being of the practice, you should start to see the numbers go in the direction that you want. While this is not an Open Book Management discussion, you do need to share certain financial data with your team so that they can stay aware of how they are doing. If the inventory manager has sheets with the vendor information on them, location in the hospital of items, reorder points, etc. his/her job becomes more efficient also. The inventory manager is the person who has the task of comparing counts to computer data to look for discrepancies. The facilitator s job is to count and be aware of what is going on in her/his zone that might impact reorder points, usage, expiration dates, etc. Inventory Managers should become familiar with preparing purchase orders in their practice management software. Keeping these purchase orders in a set place and letting everyone know where they are can cut 4
way down on people worrying about whether or not something has been ordered. Keeping people in the know is always a good thing. Hospital Usage Items used in the hospital has always been a problem. Do you count each and every needle and syringe? Obviously, not. What we have found is that if you inventory the needs of each treatment area, exam room etc. and determine that there needs to be jars at least half full of cotton balls, at least 50 of each size syringes with needles, or what have you, as the zone facilitators are going through each week surveying the areas inventory, they will note items that need to be ordered. Stockpiling syringes and needles and cotton balls makes no sense with most of the vendors offering next day delivery. Items can be moved from one exam room to another to keep rooms fully functional without stockpiling. As facilitators become more familiar with their areas, their ownership of the counting and ordering process will increase. We have seen dramatic improvement in inventory flow as people become more familiar with what is expected of them and they can see the results of their work. Opened bottles of pills in the pharmacy area are generally counted monthly as inventory management improves. What we have found is that much smaller bottles of pills can be ordered and fewer kept on hand when the process comes into maturity. While the smaller bottles may cost a few pennies more, the carrying cost etc more than makes up the difference. This is an area that may work differently in your office. As the inventory management process improves, the method of tracking last box used, also improves. Over the years I have heard all kinds of variations of how this is handled. Tear off the box flap and put in a special location, write it on a dry erase board, etc. etc. Does it work in any of your hospitals? I see very few where it does. With weekly counting and awareness of the issue, stocking out on AA, A and B items rarely occurs any more. The facilitator sees that the last box is opened, the manager notes the reorder point, and the item is reordered. Other Items Signing for inventory. Has it ever happened in your hospital that the UPS delivery man has your receptionist sign for three boxes but only drops off two? Probably never but it could. Make sure your receptionists or whoever signs for packages knows the protocol. Look at what the manifest says and make sure you are signing for what you think you are receiving. Look at the packaging. If the box is damaged or water soaked or appears to be jeopardized, make sure that whoever is signing for the package inspects the contents to be sure they are okay. Once you sign for a package, generally you are agreeing that it is in good order and you are accepting it. If you sign you received three packages but only actually received two, it is your problem to make it right. And depending on your relationship with the vendor, generally you lose. Unpacking Inventory When we have good zone facilitators, generally they want to be responsible for unpacking inventory when it is received. Teach them about packing slips and how to reconcile what is received against the packing slip. For items with expiration dates write the expiration date into the expired drug log so this can be monitored. Make sure that the packing slip is initialed and dated by the person doing the unpacking and then it is given to the Inventory Manager. Teach your zone facilitators how to stock the shelves people with retail experience understanding rotating stock but it is not something that we are born knowing. Controlled substances generally require a second set of initials verifying receipt of the items. In the event of the facilitator s absence, the labeling of drawers and shelves and the listing of what 5
goes where helps tremendously to have someone else unpack and stock shelves. A place for everything and everything in its place! Inventory Pricing If we have inventory managed well, but priced incorrectly, we still won t solve all of our problems. So where do we begin? There are many different pricing models. Profitability analysis is one. We need to cover the cost of the product, the cost of getting it to the pet/client and PROFIT to the hospital. To do this, we need to figure out the total cost of the product, i.e., what the vendor is selling it to us for, and the costs of stocking, ordering, counting, insuring it, the variable costs of selling the product, DVM and staff, and the profit you need to make on the product. Add all of these costs together and that gives you the starting point for the selling price. The variable costs can range from 20 to 25% and the holding/stocking costs from 20 to 35%. How much profit do you want to make? 15 to 20% is the minimum. Cost Pricing is another method. This generally involves mark up factoring. Faster turning items generally have a lower markup than items sold less frequently. According to the Well Managed Practice Study, National Average Markups are: Dispensed Medicine... 140... 175% HW/Flea Products... 100% Prescription Diets... 45% Non Prescription Diets... 38% OTC Items... 120% Drugs Administered... 150% Oncology... 105% Outside Lab... 130% Chronic drugs... 100% Obviously if you are matching on-line pharmacies these numbers can change. Items that are annuities for your practice, i.e., drugs that animals are on for their life time, generally have a much lower mark up. Remember also, that you should have a minimum charge in your hospital. For some less expensive items, a.01 cost even with a hefty markup becomes too small to bother with. A minimum per unit cost of ten cents makes more sense. You need to have a dispensing fee for any prescription item that is transferred from its original packaging. Somehow you have to be paid to have someone count out pills, print a label, double check instructions, etc. This can vary from $4 to $10, most common $9. Any time you have a label put on an item even if dispensed in its original package, you need to charge a labeling fee. This covers the doctor s approval, and putting a label on the package as required by law. This is generally anywhere from $2 to $5, most common $7. In addition, you should have a minimum prescription fee. If a small quantity is dispensed or a low cost item, there is still a cost associated with getting it to the client. A minimum prescription fee generally starts in about the $12 range. In addition to these fees, the other pricing model is obviously price matching. If you do match on-line pharmacy prices, make sure your clients know that you do. They are constantly bombarded by advertising that says you are too expensive. If you match, let them know. Many times I find veterinary hospitals are actually less expensive than on-line pharmacies. I am not promoting this model, just saying if you do it, let people know. 6
If you are looking for help in setting prices, AAHA has a fee reference guide, The Well Managed Practice Study has some ideas and NCVEI.org can be a resource. There are also computer programs out there that can help. When is a Deal a Deal? Be careful. Generally you have to have a true savings in excess of 10% before this makes sense. Usage changes when there is lots of stuff sitting around. Usage is very important, you have to sell it all before you have to pay for it. Remember, you do have to pay for it so Cash Management is very important. Questions? Comments? Disagreements? 7