A drop in cash flow doesn’t automatically mean a drop in gross profit (Pharmacy Guild – September 2013)

Some of the recent changes in the way pharmacy is funded may have had a major impact on the appearance of your pharmacy’s financial statements.

Decrease in cost of medicine

One of the main influences has been the significant decrease in the cost of a number of medicines over the last 12 months or so. A large portion of a pharmacy’s revenue is derived from reimbursements of drug costs, so this drop has had a major impact on both income and purchases and should have reduced value of stock on hand.

Holding all else equal and still maintaining the same dollar margin on products, a decrease in sales and an equal decrease in purchases should have the effect of increasing gross margin percentage and maintaining a similar total gross profit.

A simple example:

 Higher  Lower
 Sales $100 $80
 Purchases (Cost of Sales) $65 $45
 Gross Profit (Sales – Cost of Sales) $35 $35
 Gross Profit Percentage (Gross Profit/Sales) 35% 44%

In this example, an initial drug cost of $65 has been dropped by $20 to $45. Therefore, the amount of total revenue (sales) has also dropped by $20 from $100 to $80. This has the effect of increasing the original gross profit percentage from 35% to 44% and because in dollar terms the loss in revenue is equal to the decrease in cost of sales, the gross profit of $35 remains the same.

While this is a very simple example, and it assumes that the remaining portion of revenue (service revenue) remains constant, these are the trends that pharmacies have recorded for the March 2013 year.

But what about growth?

A similar gross profit to previous years may in itself be considered abnormal to pharmacies that traditionally grew around 5%& per year. If a pharmacy has not maintained control of its expenses, such as wages, rent and advertising, then this may be causing difficulties including loss of profits and decreased cash flow.

Stock, stock, stock
Another potential strain on cash flow is the amount of stock the business is holding. If similar physical stock levels as previous years are held, and the cost of stock has decreased, the cost of the stock that the business holds should also have decreased. Many pharmacies are not indicating that the cost of their stock on hand has decreased, which leads us to question why they are holding more stock than in previous years. We are not sure whether the timing of Easter (Easter Sunday was 30th March) could be a reason, or whether pharmacies are not running their stock levels as efficiently as in previous years. Stock levels are vitally important; this is where a large portion of businesses’ working capital is tied up. If a business is holding more stock than it needs to, this ties up excess cash and can create cash flow issues. Maintaining tighter control of stock also limits wastage.

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Published in Contact Magazine September 2013 written by Atul Mehta.

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