Purchasing and Inventory Management

Inventory management means minimizing the investment in inventory while balancing supply & demand. Proper management of inventory has a significant impact on both the financial & the operational aspects of any pharmacy. * Having the right product at the right time at the right price is essential to meeting consumer demand. @ the same time, pharmacy managers desire to minimize inventory investment.

From a financial perspective, effective inventory management ↓’s cost of goods sold & operational expenses → ↑’d gross margins & net profits. *From an operational perspective, effective inventory management is important in meeting consumer demands for both goods & services. (e.g., not having the needed product @ the right time →lose a sale or physical harm to a hospitalized pt.)

PURCHASING: Purchasing is actually a substantial investment process. * Involves buying the right products in the right quantity @ the right price @ the right time from the right vendor

Right Product: The pharmacy manager should evaluate the following factors when deciding what products to order: 1) Past usage (Review drug use reports & Rx orders) 2) Target market ( Market of pharmacy location) 3) Pharmacy image & goals (Product should complement pharmacy’s image) 4) Formularies (Based on clinical & economic benefits. Stock more 3rd party covered formulary items. Nonformulary items to be ordered if needed) 5) Industry data (Publications alert to new products or product changes that may affect prescriber & patient needs) 6) Industry representatives (Provide information about available, new, or soon-to-be released products & prescribing habits in local area) 7) Consumer information (Ask patrons, prescribers, & employees. Monitor consumer requests)

Right Quantity at the Right Time: Too much product ties up a pharmacy’s money without providing an adequate return on investment. Too little product may result in lost sales & profits & inconveniences pharmacy staff and customers.

The right quantity means having just enough product on hand to cover consumer demand @ any given time. * 3 of stock to consider in deciding how much & when to order: 1)Cycle stock: regular inventory that is needed to fulfill orders. 2) Buffer (safety) stock: additional inventory needed in case of a supply or demand fluctuation. 3) Anticipatory (speculative) stock: inventory kept on hand because of expected future demand or expected price ↑ (e.g., flu vaccine in fall & winter months), but RISKY.

To estimate min. quantity of goods needed to meet demand, purchasing agent should know the following for each item stocked: 1. How much is on hand 2. At what point to reorder 3. How much to order

To establish stock depth (product quantity) should consider: To determine stock depth (i.e., the point where it is reasonably certain that the item will be available on demand)? To establish stock depth (product quantity) should consider: 1. Item’s rate of sale (average demand) 2. Length of time between stock checks (review time) 3. Time period between placing & receiving an order (lead time) 4. A safety stock to account for variations in average demand during the buying time (review time + lead time)

formula to set the reorder point is Reorder point = [(review time + lead time) × average demand] + safety stock This was used to develop an economic order quantity (EOQ). The EOQ model describes the level of inventory & reorder quantity @ which the combined costs of purchasing & carrying inventory are @ a min. Q = economic order quantity c = procurement cost per order D = demand for the product in $ or others I = inventory carrying costs UC = unit cost of the item

Another factor determining how much to order is the budget. Hospital pharmacy directors may estimate this year’s budget by ↑’ing last year’s budget by a certain % (e.g., 5 or 10 %). * This budget estimate will provide a guide for how much money can be spent each month to order product. Community pharmacy managers also evaluate the profit-&-loss statement to determine whether too much product bought compared with the amount of sales.

Basic steps of an open-to-buy budget purchase technique which is repeated on a monthly basis, include: Step 1. Forecast purchase budget for each month in the next fiscal year based on sales and cost of goods sold (COGS) data from the preceding year. Step 2. Each month’s forecasted sales are then multiplied by the COGS percent to calculate the monthly unadjusted purchase budget. Step 3. @ the end of each month, the month’s actual sales & purchases are recorded. Next month’s purchases are then adjusted based on the past month’s actual sales and purchases. *If sales were > than predicted → next month’s purchase budget may be ↑’d *If the sales were < than expected → the purchase budget for the next month would be ↓’d.

Right Price Once the right product is selected, it is important to acquire it @ the right price. Terms of sale pertain to: A) Discounts: describe the reduction(s) in price &B) Dating: pertains to the period of time allowed for taking the discounts & the date when the invoice becomes payable.

3 main discounts: Quantity discounts: Incentive for purchasing large quantities of single products or a special grouping of specific products offered by a manufacturer a)Noncumulative quantity discounts: * Based on a quantity of the same product being purchased on the same order b) cumulative (deferred) quantity discounts: If the total purchases reach a target monetary amount during a specific time period. Involve a variety of products on separate orders over a period of time

2) Cash discounts: Small discounts offered for the prompt payment of invoices Stated as a % of the amount remaining after all other discounts have been deducted from the bill. * A common discount is “2/10 EOM, net 30,” Means a 2 % discount if the invoice is paid within 10 days of the date of the invoice or the net amount is due in 30 days *Additional cash discounts may be offered for prepayments: to pay a week or month ahead of actual purchases based on its average weekly or monthly purchases over the last 3-6 months. * Payments may be done through Electronic funds transfer (EFT)

3) Serial discounts: *When multiple discounts are applied @ the same time. Taking advantage of both quantity & cash discounts.

B) Dating of the Invoice: *Refers to both a) the time before the specified amount of discount may be take & b) the time at which payment becomes due There are 3 general types of dating: 1) Prepayment: the pharmacy pays for the merchandise before it is ordered & delivered, 2) Collect on delivery (COD): no time before a discount may be taken & payment becomes due, 3) Delayed or future dating: the invoice is due sometime in the future *When no specific dating has been placed on the invoice → usually assumed that payment is due 10 days from the last day of the month in which the purchase was made. *AOG: “arrival of goods,” & ROG: “receipt of goods.” Example, “2/10 ROG, net 30” → deduct 2% & within 10 days after receipt of goods or pay net within 30 days after receipt of goods.

Right Vendor: Being able to obtain the right product at the right time at the right place depends on the vendor. (be careful) Advice: Pharmacies should have a 1⁰ vendor & a 2⁰ vendor. Establishing a (+) relationship with a vendor can: → a) prompt delivery, b) special buying opportunities, c) special pricing information, & d) prompt problems resolution.

*A 2⁰ vendor is advised for when product is not available from 1⁰ vendor (product shortages ) & to obtain special pricing opportunities. When selecting vendors, consider : Favorable pricing Purchase terms Good reputation Accuracy Fill rates Quality products & services Have few out-of-stock situations. Prompt & reliable delivery.

Pharmacy managers should evaluate their vendors periodically →to ensure competitive prices & discounts * Types of Vendors: Wholesaler or distributors “middlemen” (most common): *Search the marketplace & buy a wide variety of products from thousands of different manufacturers & vendors → sell them to pharmacies for use & resale. Most are “full-service” wholesalers: serve as a buying agent → anticipates the pharmacy’s needs, goes into the market to get the necessary goods, & has them available @ the appropriate time. More efficient to deal with a full-service wholesaler than to have to purchase products from each vendor separately. * Most wholesalers offer just-in-time (JIT) delivery → allows for next day delivery → ↓’ing the pharmacy’s risk & ↑’ing the pharmacy’s cash flow

Full-service wholesalers: * Assemble various product lines *Render other valuable programs & services may be offered free or for a fee: *provide information on marketing & merchandising techniques, *assist with pharmacy layout & design, *provide customized inventory management reports & information on the availability of new products. *private-label products, *repackaging services, *backorder programs: as soon as the wholesaler receives the product → the pharmacy’s backorders get top-priority filling & shipping status *some offer “delivered on consignment products”: the pharmacy does not have to pay until the product is sold programs *some offer ownership programs: assist people with buying a pharmacy by providing special financing for the initial inventory, store layout design consulting, & others *3rd -party assistance services include:

Pharmacies (i.e., Hospital) can participate in some type of group purchasing organization (GPO) or central purchasing organization → to pool the buying power of pharmacies together for better prices & discounts from vendors. A pharmacy buying group: a pharmacy organization to seek better for its members (e.g., community pharmacies, hospital pharmacies, and long-term care facilities) based on their collective buying power. Most buying groups charge a monthly or annual fee to members.

Purchasing: A designated person submits an order via telephone, fax, or computer & receives order confirmation The products need to be counted, checked for damage, discrepancy, & short expiration & then stocked on the shelves (newest stock behind older stock)using handheld devices that use barcoding technology. Software can be used to count incoming & outgoing products & automatically order product to replenish stock based on models such as the economic order quantity.

Inventory: The stock of products held to: Meet future demand. Guard against fluctuations in demand, Take advantage of bulk discounts, Withstand fluctuations in supply(e.g., late deliveries) . Four costs associated with having inventory: Acquisition costs, Procurement costs, Carrying costs, Stock-outcosts

1) Acquisition cost: the price the pharmacy pays for the product 1) Acquisition cost: the price the pharmacy pays for the product. 2) Procurement costs: associated with purchasing the product: checking inventory, placing orders, receiving orders, stocking the product, & paying the invoices. 3) Carrying costs: the storage, handling, insurance, cost of loss (theft, damage,…) 4) Stock-out cost: the cost of not having a product on the shelf when a patient needs it. *Procurement & carrying costs must be balanced. e.g., ↑’ing the average order size & ↓’ing the # of orders placed ↓’s procurement costs but ↑’s carrying costs

Inventory management is the practice of planning, organizing, & controlling inventory so that it contributes to the profitability of the business. The goals of inventory management: To minimize the amount invested in inventory & the procurement & carrying costs while balancing supply & demand Efficient inventory management → keeps costs down, improve cash flow, & improve service.

Evaluating Inventory Management: The most common ratio used to determine how well a pharmacy is managing its inventory is the inventory turnover rate (ITOR) & is expressed as a ratio ITOR = cost of goods sold ÷ average inventory value (at cost) ITOR = cost of goods sold ÷ [(beginning inventory value + ending inventory value) ÷ 2] The cost of goods sold (COGS) can be found on the pharmacy’s income (profit-&-loss) statement for a given period of time. The average inventory value from the pharmacy’s balance sheets. The ITOR indicates the efficiency with which inventory is used. It measures how quickly inventory is purchased, sold, and replaced.

If the pharmacy’s overall annual ITOR is 10 → this pharmacy sells all the inventory that is typically kept in the pharmacy a total of 10 X over the course of a year. Make sure that ITOR is not too high or not too low. If ITOR is too high→ may indicate out-of-stocks may be too frequent., if the ITOR is too low → may too much inventory that is not salable or not being used Deciding what is too high or too low is pharmacy-dependent The pharmacy manager should consider national or regional benchmarks as well as the pharmacy’s trends when interpreting the ITOR.

Another indicator of a pharmacy manager’s ability to manage the investment in inventory efficiently is the net-profit-to-average-inventory ratio → indicates whether the inventory is being used efficiently To make a profit → Pharmacy managers desire to have a ratio > 20%

Factors to Consider in Inventory Management: Selection of generic products (lower acquisition cost) 2)Reduction of inventory size (carry only basic product lines) 3)Returned-goods policies (credit on future purchases, replacement goods, or even cash back to the pharmacy)

4) Management of unclaimed prescriptions: (monitor the unclaimed prescriptions & after a specified period (e.g., 14 days) return the stock to the shelf.) 5) Monitoring shrinkage: (losses owing to shoplifting, employee theft, & robbery →recruit honest personnel & monitor their activities, install security mirrors & cameras) 6) Use of formularies: (allows the pharmacy manager to carry onetherapeutic equivalent within a class of drugs & lower their overall investment in inventory.)

Methods of Inventory Management: Three methods are used commonly in pharmacy to manage inventory: The visual method, The periodic method, The perpetual method

The visual method: A designated person to look at the # of units in inventory & compare them with a listing of how many should be carried. *When the # ↓’s < the desired amount → an order is placed. 2) The periodic method: A designated person to counts the stock on hand @ predetermined intervals & compares it with min. desired levels. *If the quantity is < the min. → the product is ordered. 3) Perpetual systems: Computerized inventory management systems. * The most efficient method. * Allows the inventory to be monitored @ all times. *The entire inventory may be entered into the computer, & with the filling of each Rx, the appropriate inventory can be ↓’d automatically. *Can tell precisely amount of inventory on hand for any product @ any time. *Can quickly assess the value of current inventory. *Computer systems can be used to calculate the EOQ and reorder point so that a product is reordered

It is important to conduct a physical inventory to verify periodically the accuracy of the pharmacy’s financial records. Examples: * Purchase-trend report—describes the quantity purchased of OTC products or Rx drug products by month or by quarter. Sales-analysis report—features a rolling 12-month statement that includes order quantity, shipped quantity, unavailable quantity, returns, credits, and dollars spent. Item-movement report—lists which items are selling the best