Cost of goods is the highest expense in mixed animal practices, and the second highest expense in companion animal hospitals. Yet, it’s one of the most ambiguous areas of veterinary practice management. Responsible veterinarians who try to manage their cost of goods are often advised to lower their spending. They’re given advice such as, “Your purchases should be 20% of sales every month,” or simply, “You’re buying too much.” However, this advice is almost always given without any veterinary industry data or knowledge of how much is being sold. For a veterinarian who is selling twice the average amount of goods, their cost of goods sold will be twice the average.
What is cost of goods sold?
The term “cost of goods sold” (COGS) is used to describe the amount a veterinarian will spend to purchase anything that is sold to a client, such as pet food, medication, over-the-counter products and toys. In veterinary medicine, cost of goods also incorporates the cost of products that are used to deliver services, but are not sold directly to the client, such as gauze, antiseptic, suture material, and vaccines. Separating the amount used in the hospital from the amount sold to clients is ideal for managing purchasing, but this rarely happens. So, remember that when accounting for cost of goods sold, this is actually “cost of goods used in the practice” (or COGUIP).
Myth: One size fits all
The most common myth is that everyone can use the same number to manage their cost of goods. This must come from other industries in which product sales are more consistent. If sale of products always represents 50% of revenue, then one figure would work in all situations. In veterinary medicine though, there is variability in pet food and pharmacy sales. A companion animal veterinarian with a keen interest in nutrition may sell twice the amount of food and will therefore have twice the COGS. The average revenue from product sales may be 40% of gross revenue (15% pet food and 25% pharmacy), but the range for most practices is 32% to 48%.
The markup on products sold through the pharmacy will affect the contribution to revenue and resulting COGS. If one hospital sells a product for 25% less than a second hospital, the first hospital will have lower revenue and cost of goods will be higher. For example, suppose a product costs $10 to stock. If one hospital marks it up 100% and sells it for $20, their total revenue is $20, and their cost of goods is $10 or 50%. If a second hospital marks up the same product 50% and sells it for $15, total revenue is 15% and cost of goods is 67%. The two hospitals sold the same product, but the cost of goods varies because the markup varies.
Another factor that affects the cost of goods is professional fees. If two hospitals charge the same markup on products, but one charges twice as much for professional services, the COGS will differ greatly (Table 1).
Table 1.
Factors affecting the cost of goods sold./Facteurs affectant le coût des produits vendus.
| Hospital 1 | Hospital 2 | |
|---|---|---|
| Sale of professional services | $100 | $200 |
| Sale of products | $100 | $100 |
| Total revenue | $200 | $300 |
| Cost of products | $50 | $50 |
| COGS percentage | 25% | 16% |
Hospital 1 should have no problem keeping purchases below 20% of gross revenue, but it would be impossible to lower cost of goods to below 25%.
Myth: Hospitals need to decrease purchases
When veterinarians ask for assistance managing their COGS, many consultants assume there’s a problem. Their first reaction is to suggest a decrease in spending. If the cost of goods is lowered, and all things are equal, expenses will be lower and there will be an increase in profit. But many hospitals are already purchasing responsibly. If purchases are lowered, the hospitals will start to run out of inventory. Most hospitals have a great relationship with their distributors and order products as they need them. They sell a bag of dog food to a client on Tuesday and then order a replacement bag on Wednesday. The hospital’s purchases match client purchases.
Other problems with decreasing inventory are, for example, higher sales of parasite medication due to increased prevalence of ticks and increased pet food sales through veterinary webstores. The introduction of tick prevention medication in the last few years has resulted in a new source of revenue for veterinary practices but it has also resulted in higher purchases. Similarly, many hospitals are finding an increase in pet food sales from offering online purchases through their webstore. Increased sales associated with automatic reorder is increasing both diet revenue and diet purchases.
Reality: Revenue from sales varies and so should cost of goods
Data from the 2016 Practice Owners Economic Survey provides direct evidence on the variability of purchases. It explains the trend associated with revenue from products and the resulting cost of goods. Many veterinarians know that increased product sales will lead to increased purchases, but many believe that they can keep purchases as a percent of revenue stable regardless of product sales. They think that keeping purchases at 20% of gross revenue is possible as product sales increase. The data show that as the contribution to revenue increases, so does the cost of purchases as a percent of revenue. As product sales as a percentage of revenue increases, so do product purchases as a percent of revenue. If product sales as a percent of gross revenue increase, so does product purchases as a percent of revenue (Figure 1).
Figure 1.
Companion animal product sales and cost of goods.
For companion animal practices, the cost of goods rises a 1/4% with each percent increase in sales. For example, if a hospital increases sale of products from 40% to 44% of revenue, COGS will go up 1%.
In mixed and large animal practices, in which the sale of medications is a bigger part of the practice, the cost of goods goes up 0.38% for each percentage contribution from product sales (Figure 2). If a dairy veterinarian adds a large herd to the practice, medication sales, as a percent of gross revenue, may go from 40% to 50% and the cost of goods would go up 3.8%.
Figure 2.
Mixed animal product sales and cost of goods.
Product sales can be calculated as a percentage of gross revenue and entered into the following formulae:
The range in markups and professional fees means the equation may not fit all hospitals. Since the cost of goods varies, be sure to use numbers that reflect your hospital’s sales practices.
Footnotes
This article is provided as part of the CVMA Business Management Program, which is co-sponsored by IDEXX Laboratories, Petsecure Pet Health Insurance, Merck Animal Health, and Scotiabank.
Use of this article is limited to a single copy for personal study. Anyone interested in obtaining reprints should contact the CVMA office (hbroughton@cvma-acmv.org) for additional copies or permission to use this material elsewhere.