Understanding Your Pharmacy Income Statement: Part II

Having a solid understanding of your independent pharmacy’s financials can spell the difference between your business’s success and failure. While you may have an accountant whom you trust to prepare your financials, having a grasp of your pharmacy’s financials can aid in better business decisions, day-in and day-out.

As we continue this three-part series, we’ll break down gross profit and operating expenses, both of which are key components of your income statement that ultimately impact your business’s bottom line. As discussed in Part 1 of the series, gross profit is directly affected by how well you manage your revenues and cost of goods sold.  

Gross Profit: What it Means

Gross Profit = Revenue (or Sales) – Cost of Goods Sold

Gross profit is the monetary amount that remains after selling a product and deducting the costs associated with that product. It stands to reason that by regularly monitoring your revenue and cost of goods sold, you can increase your gross profit. It’s important to note that operating expenses do NOT impact gross profit. Therefore, expenses such as employee salaries, rent/lease, utilities, advertising, etc. do not affect gross profit (more on the concept of operating expenses later in the series). Rather, gross profit is the starting point of how much cash you have to cover those operational expenses.

Why it’s Important

Cash flow is an essential component to your business. When you’re aware of your pharmacy’s gross profit, you’re aware of your accessible resources (i.e. cash) available to operate your business. Your gross profit funds your operations and business growth. Understanding gross profit allows you to manage expenses and allocate capital appropriately within the business. Gross profit is a good indicator of the health of your business and how effectively it’s run. While gross profit dollars are the most important, you should also review it as a percentage of revenues, known as gross margin. Gross margin is calculated by dividing gross profit into the revenues.

Here’s an example: A customer of your pharmacy buys a bottle of fish oil capsules for $15. Your cost of goods sold is $10 per bottle. Therefore the $15 sale minus the $10 cost of goods sold equals $5 gross profit, or ~33% gross margin. If you’re not monitoring your basic pharmacy financials, you may not properly price the products that you sell to maximize your gross profit. To that end, if you sold that same bottle of fish oil for $12 revenue, minus $10 cost of goods sold, that leaves you $2 in gross profit or ~16.5% gross margin. That’s $5 in the first scenario versus $2 in the second scenario that you’d have to cover your staff’s pay, equipment costs, taxes, and the like. Again, the higher your gross profit, the more funds you have available to grow your business.

Ways to Increase it

There’s a variety of ways to increase your gross profit, including managing inventory and increasing sales. After all, there are more items for customers to buy in your independent pharmacy than just prescriptions. Here are some strategies to consider:

  • Manage prescription cash pricing and third-party reimbursements to ensure the pharmacy is reimbursed the proper amounts.
  • Properly manage all of your inventory, especially your prescription drugs, through inventory controls such as perpetual inventory management, just-in-time inventory, and/or electronic interfaces.
  • Ensure you maximize your purchasing plan(s) through your suppliers to attain the best cost of your inventory.
  • Entertain pharmacy-specific niche markets such as compounding, home-healthcare equipment (DME), immunizations, etc.
  • Promote non-Rx departments, such as over-the-counter (OTC) items, to increase traffic resulting in increased sales.

Operating Expenses

Remember the formula:

Revenue – Cost of Goods Sold = Gross Profit – Operating Expenses = Net Profit

Since the goal for any business is to boost its bottom line (or net profit), keeping your controlled expenses in check is key. Those expenses impact your business’s cash flow, so monitoring them is imperative. Here, we continue our income statement series by exploring operating expenses.

What it is

Essentially, operating expenses are the expenditures that your business incurs while conducting its business operations. This includes rent, employee salaries and benefits, utilities, computers and other workplace equipment, marketing, office supplies, bank fees, and more.

However, inventory is not an operating expense. Inventory, or the merchandise that you purchase for resale, is a cost of goods sold (see more on cost of goods sold in part one of this series). For example, the cost of the prescriptions that you buy from a supplier (to then resell to your customers) is a cost of goods sold (COGS). Therefore, the general rule is this: if an expense is not related to COGS, it’s considered an operating expense.

Why it’s Important

It is crucial to optimize expenses to be as lean as possible without the potential of impacting the customer experience.  

It’s safe to say that you want to increase the cash flow of your independent pharmacy. One way to achieve this is by monitoring, and ultimately reducing, your pharmacy’s operating expenses. However, this can be a Catch-22. Lower some areas of operating expenses too much and you run the risk of affecting your business’ ability to compete in the marketplace.

To that end, you want to keep operating expenses as low as possible but not to the detriment of your business. For example, let’s say that your pharmacy is known for providing exceptional customer service. This may be what sets you apart from the big box-type pharmacies — providing your edge over the local competition. Now assume you consider reducing the number of technicians as a means of cutting expenses. While this option may be feasible on a slower weekday, it may not be a wise strategy to employ on a busier day, such as Monday or the first of the month. This may lead to your pharmacist having to perform more functions usually handled by that technician. As a result, it may cause longer check-out times for customers who count on fast and friendly service in your store — causing them to take their business elsewhere.

Again, strive to reduce operating expenses, but not at the risk of watering down your business. It may take some time to determine the right balance, but the investment will be worth it.

Ways to Improve it

It is possible to strike and maintain the proper balance in your operating expenses. Various strategies exist to lower your operating expenses, which in turn increases your net profit. Here are some options to consider:

  • Prepare a budget to measure and monitor all of your operational expenses. You’ll establish a benchmark and easily identify areas of cost-cutting opportunities.
  • Ensure you are staffed properly. Labor costs are usually the largest expense in the pharmacy. Understanding how much labor is necessary can save significant labor costs.  
  • Cut the cost of supplies where possible; they are necessary costs to the business but generally do not affect the customer.
  • Go Green – energy-efficient technology reduces energy costs.
  • Always monitor lease/rental agreements and other contracts to ensure they are within market ranges. Review and discuss contracts at least annually and discuss money saving options.
  • Reduce your utility bills. Small changes like turning off computers after hours, installing timers on lights, and replacing your old thermostat with a programmable one can lighten the load on your electric bill.

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Stay tuned for part three of a three-part series which will cover net income in more detail.