August  2016    
Volume 8, Issue 8    

Analyzing Costs
of Goods

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Second only to the cost of labor, the cost of goods sold (COGS), sometimes referred to as the cost of professional services (COPS), is one of the biggest expenses in a veterinary hospital. If your hospital's profitability is not where you want it to be, evaluating your COGS is always a good first step.. According to the most recent data from the American Animal Hospital Association, the median COGS for a veterinary practice is 23.5%. By comparison, the publication "Benchmarks 2015: A Study of Well-Managed Practices" shows average COGS of 22.8%. 
These national benchmarks give you a starting point for understanding your practice better. But remember - if you want to have a highly profitable practice, you need to do better than the "average practice" that is represented in these studies. Ideally, you should try to shoot for total COGS of 20% or lower of total revenue. How can you get there? Keep reading!
The first step is to break down COGS into categories that are more meaningful. We have seen a wide variety of expense detail in the practices we work with, from those that lump everything into a single "drugs and supplies" category to those that break expenses down into extremely specific categories, such as drugs: antibiotics and drugs: anti-inflammatories, etc. You may have heard the expression that "you can't manage what you don't measure", but it doesn't necessarily hold true that "the more you measure, the better you will manage!" In many cases, overly detailed categories do not help you manage your business better - they just cause information overload! 
We recommend breaking down expenses into categories that are meaningful to your practice. The most common categories are drugs and medical supplies, laboratory costs (inside and outside), food or diet products, over the counter products and cremation. Break down the categories further if there are areas you wish to understand better. For instance, you may want to break out flea/tick/heartworm products from the drug category. You might want to understand how much money comes from surgery, anesthesia, dentistry, etc. 
Once you have the expense categories you wish to track, we strongly recommend that you try to "pair-up" your income and expense categories. In other words, if you already break down income into areas such as Surgery, In-House Laboratory, Outside Laboratory, Surgery, Rehab, Pet Food, Flea/Tick/Heartworm, etc., then you should break down your expenses the same way. By doing this, it is easier to determine where profits are generated in your hospital and where price increases might be needed. You will also have a much better chance of reducing your COGS with this type of structure. 
Now let's compare your practice expenses to one of the national benchmarks listed above, using pet food as an example. According to AAHA's Financial and Productivity Pulsepoints, the average practice spends 3.3% of total revenue on pet food. According to the Benchmarks 2015 publication, the average food expense is 3.1%. If you look at your practice expenses, and you find that food expense is 5.0% of total revenue, that means that you spend way too much on food, right? Hold on, not so fast!
This is why it is important to understand your income as well as your expenses. According to Pulsepoints, the average practice generates 4.6% of their total revenue from the sale of pet food and the Benchmarks data says 4.3%. If you track your pet food revenue as well as your pet food expenses, you can now put your data into context. That expense of 5% is way too much if you are generating only 4-5% of revenue from pet food sales. On the other hand, if you generate 10% of revenue from pet food sales, then the 5% expense is outstanding! 
How do we know this? By looking at income: expense ratios. These ratios can be very helpful when you analyze your expenses as they compare to national benchmarks. What is even more important is that they can help you evaluate your expenses over time. Going back to our pet food example, let's say that your practice generates $1,000,000 per year and your pet food expense is 5% ($50,000). If you generate 10% of your revenue ($100,000) from pet food, your income to expense ratio is $100,000/$50,000 or 2.0. We know this is excellent, because the national benchmarks for average income: expense ratios are 1.4 to 1.5. If you generate $2 for every $1 you spend, then your COGS are in good shape when it comes to food.
On the other hand, if you have expenses of 5% for food and income of only 5.5% ($55,000), that means your income to expense ratio is now $55,000/$50,000, or 1.1. This ratio indicates that you are only making $1.10 for every $1.00 you spend on food! This is clearly an area you would want to improve quickly. If your income to expense ratio is lower than the national benchmarks it may be an indication that you aren't raising your prices as your food costs are going up. On the other hand, you could have spoilage or wastage that is increasing your costs. It is also possible that food is "walking away from the hospital" in the hands of your clients or your employees, through missed charges or even theft. 
It is important to understand how different income areas affect your hospital. For example, you might think that the more food you sell, the better it is for your hospital. Well, that may not be the case. If the average practice only generates around $1.50 for every $1.00 it spends, that means the COGS for food is actually 66%! This means that the more you rely on food sales to generate revenue for your hospital, the higher your COGS will be!
The best way to manage your COGS is truly to understand them. By matching your COGS categories to your income categories and keeping track of income: expense ratios, you will be able to identify quickly those areas where costs are rising. All of these tools will provide more information to help you to get your COGS under control! 

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