Inside: Inventory is your pharmacy’s biggest investment. Learn the pharmacy inventory control methods you need to make the most of your inventory.
Inventory control is a sky-high balancing act.
Pursue one inventory goal and your pharmacy tilts left; pursue another goal and it tilts right.
Go after one too much over the other and you crash to the cold earth.
But when you pursue the right goals, you walk in perfect balance.
The stakes are as high as a tightrope for your pharmacy business. Your inventory is your largest investment, accounting for about 68 percent of total expenses.
And every 1 percent change in an average pharmacy’s costs of goods can shift profits by 20 percent.
Which makes every move matter.
It also means that if done well, pharmacy inventory management can drastically improve your pharmacy’s bottom line.
And ensure a steady cash flow.
Read Next: The Complete Guide to Pharmacy Inventory Management (Includes 7 Formulas)
The Balancing Act of Inventory Management
The primary goal of inventory management is to minimize the total cost of inventory while meeting demand.
That’s the great balance: selling as much as you can while holding as little as you can.
Too much inventory on the shelf pinches your cash flow. Too little inventory pinches your profits (and could cost you patients if you don’t have their medication in stock.)
Here are some of the costs associated with inventory:
- Ordering costs: Costs of placing an order, receiving and verifying the order, and putting away the stock. The more often you order product, the more you’ll pay in ordering costs.
- Holding costs: Opportunity costs of cash sitting on a shelf instead of in your bank. The more product you keep on the shelf, the less cash you have to pay down debt, pay bills or pay suppliers. And the more product you hold, the more likely you’ll risk expiration.
- Shortage costs: Costs of not having the inventory on hand when you need to fill the prescription. The more often you have shortages, the more you lose in lost sales, lost customers, and expedited shipping.
Read next: How to Maximize Rebates and Profitability on Pharmacy Inventory
3 Pharmacy Inventory Control Methods for Independent Pharmacies
The right pharmacy inventory control methods help you manage your inventory to find the optimal balance. Each method provides its own approach for controlling the amount of inventory you buy and how often you buy it.
1. Just-in-time method
In the just-in-time method, you order products as you need them. This method focuses on keeping a minimal amount of inventory on hand. Instead of keeping safety stock available in case you run out of product, for example, you reorder stock when it’s about to run out.
Pros of the just-in-time method:
- Keeps an absolute minimal amount of inventory, which limits holding costs
- Reduces the amount of overstock and expired products
Cons of the just-in-time method:
- Increases ordering costs
- Risks not receiving inventory shipment when you need it
- Limits purchase volume, potentially missing out on distributor discounts
- Requires stable prediction of demand
How to make the most of the just-in-time method:
Utilize your perpetual inventory system to properly forecast demand and alert you to order at the right time.
And partner with a reliable wholesaler or distributor that will always ship you the right products when you need them. Look for VAWD-certified wholesale distributors and members of the Healthcare Distribution Alliance (HDA).
2. Open-to-buy method
In the open-to-buy method, you create a monthly buying budget based on your planned sales.
Unlike the just-in-time ordering method, open-to-buy calculates how much inventory you’ll need for the month to meet your planned sales. It’s a proactive rather than a reactive approach.
Here’s the open-to-buy formula:
Planned Sales + Planned Markdowns + Planned End of Month Inventory – Planned Beginning of Month Inventory
This equals how much you can spend on inventory that month.
Each month you’ll approach your inventory armed with a specific dollar amount to spend.
Pros of the open-to-buy method:
- Allows better utilization of cash flow
- Ensures enough inventory to support planned sales
- Gives you complete knowledge and control of your expenses
Cons of the open-to-buy method:
- Requires accurate forecasts in hard-to-pin-down categories
- Doesn’t adapt well to changing monthly demand
- Can result in loss of profit through markdowns to get items off the shelf (applicable for front-end inventory)
How to make the most of the open-to-buy method:
Dig deep into your pharmacy’s inventory and sales data. Pin down the seasonal trends and the purchasing trends of your patients. From detailed data, you can create a more accurate budget to better meet the demands while sticking to your financial plan.
Or, customize your budget with more precision and better control using the “ABC analysis.”
The ABC analysis breaks down your inventory into three categories: A, B, and C:
1. The A category
The A category contains products you should always have on hand. They’re your top-selling, highest-turnover products. Generally, A products make up about 10 percent of inventory but 70 percent of sales.
2. The B category
Categories B and C contain lower-demand products with slower turnover rates. Generally, B products make up 20 percent of inventory and 20 percent of sales.
3. The C category
C items make up 70 percent of inventory and only 10 percent of sales.
Budget your inventory according to the ABC categories to make the most of your investment.
3. Min/max method
In the minimum/maximum method, you determine a minimum and maximum number of products you want in your inventory at any given time. Your inventory never drops below the minimum or goes above the maximum.
This method focuses on keeping inventory at consistent, economic levels. Instead of ordering a budgeted amount every month, for example, you continually order to always keep stock available without going overboard.
Pros of the min/max method:
- Helps maintain a balance between ordering costs and carrying costs
- Ensures you never run out of inventory
Cons of the min/max method:
- Less control over spending
- Requires significant time to establish and regularly update the min/max levels
- Might not properly account for changing demand
How to make the most of the min/max method:
Create minimum and maximum levels for each of the ABC categories of inventory. This allows you to create more controlled limits for your most crucial inventory.
Or, set your limits using the Economic Order Quantity (EOQ). This formula determines how much you need to purchase per order for the perfect balance of cost and demand.
The EOQ formula finds a mathematical sweet spot based on annual cost and demand data.
Here’s the EOQ formula:
Square root of [(2 x annual product quantity x ordering costs per order) ÷ storing costs
The result of the equation is the amount of product you should purchase each time you order.
So, the difference between your maximum and your minimum should equal that number.
For example, if your EOQ is 25, your min could be five and your max 30. When your inventory reaches five, you’ll order 25 more product to fill your inventory back to the 30 maximum.
How to Make the Most of the Pharmacy Inventory Control Methods
These pharmacy inventory control methods are best used in conjunction with each other to optimize your inventory for your pharmacy’s particular needs.
When used with your perpetual inventory system, these methods can minimize inventory and maximize turnover.
For example, your perpetual inventory system can alert you when the minimum has been reached or if it’s time for a just-in-time order.
The perpetual inventory system will also help improve decisions regarding your control methods by providing historic and real-time data. For example, it can help you spot trends in demand—both in general and for specific categories of products.
A Member-Owned Company Serving Independent Pharmacies
PBA Health is dedicated to helping independent pharmacies reach their full potential on the buy-side of their business. Founded and run by pharmacists, PBA Health serves independent pharmacies with group purchasing services, wholesaler contract negotiations, proprietary purchasing tools, and more.
An HDA member, PBA Health operates its own NABP-accredited warehouse with more than 6,000 SKUs, including brands, generics, narcotics CII-CV, cold-storage products, and over-the-counter (OTC) products — offering the lowest prices in the secondary market.
