The cost of goods sold is the biggest expense in most veterinary practices after payroll. How a business manages its COGS has a tremendous impact on profitability. My objectives here are to ensure you know what the cost of goods sold includes, where to find everything, how to set a COGS goal, and what to do if your costs are too high.
What and Where Are My COGS?
The most common expenses included in a veterinary practice’s cost of goods sold are:
- Prescriptions
- Medical supplies
- Vaccines
- Laboratory expenses (reference and in-house)
- Food (wellness and therapeutic)
- Over-the-counter products
- Animal body disposal
The AAHA/VMG Chart of Accounts has an incredibly detailed list of items you can include in your cost of goods sold.
Stop reading now and find your practice’s most recent profit and loss statement. Immediately after the income or revenue section should be a segment titled “Cost of Goods Sold.” If you see it, great. If you do not, ask your bookkeeper or accountant to add one. If your COGS isn’t broken out and subtotaled, the remainder of this article will not be helpful to you.
Since you are still reading, you have found the COGS section. Excellent! While we track expenses in dollars, we measure the cost of goods sold relative to revenue. We do this by having a column on the P&L statement showing the revenue percentage in each expense account.
That was the easy part. Now for the fun stuff.
Setting a COGS Goal
Many “experts” think every practice should apply a preconceived COGS percentage. That rule does not make sense. Because every practice differs in its services and products, individual COGS goals must fit each veterinary hospital.
Let’s dive into how to calculate a COGS goal by imagining two high-quality general practices with equal revenue.
Practice A’s boarding facility also offers day care and grooming. Those three non-DVM-driven services account for 15% of revenue. The hospital doesn’t sell much food. It also records its online pharmacy at net, meaning the bookkeeper records the net deposit received as revenue and doesn’t record the online store COGS.
Practice B doesn’t offer boarding, day care or grooming. The veterinary team sends all intestinal parasite screens to a reference lab. Wellness and prescription food account for 9% of revenue. The bookkeeper records the online pharmacy at gross, meaning the total sales from the monthly dashboard and the difference between revenue and profit are recorded as COGS.
The COGS goals are 20% at Practice A and 28% at Practice B. Both hospitals met their goal and have EBITDA (a fancy acronym for profit and profitability) above 20%. More than 20% is excellent.
In real life, most practices fall between the two examples. Let’s determine a reasonable goal for your practice.
COGS Theory
COGS Theory is the process of weighting your revenue mix (services and products) to determine a blended goal. Boarding and grooming have little to no COGS while selling food requires a very high one. We can reverse-engineer the goal by setting a markup expectation for each revenue segment. For instance, food commonly carries a markup of 35% to 45%.
Let’s use the midpoint of 40% to calculate the COGS goal for food.
- $1 of food at cost is sold for $1.40, a 40% markup.
- $1 of the cost divided by $1.40 of revenue is 71%.
- The cost of goods sold for each dollar of revenue is 71%.
Using that methodology, we can set common COGS goals for these revenue segments:
- Treatments, 5% (professional fees, dentistry, surgery, imaging and discounts)
- Food, 71% (calculated above)
- Pharmacy, 40% (a blend of many products and different markups)
- Vaccines, 20% (rabies with a higher markup and other vaccines with lower markups)
- Lab, 20% to 33% (20% is appropriate for practices that perform fecal and basic heartworm tests in-house. Practices that send everything except urgent bloodwork to a reference lab will want 33%.)
- Boarding, grooming and day care, 1%
The COGS goal for an online store depends on how you record the revenue and costs. If recorded at the net deposit that hits the bank, use 0%. If recorded at gross revenue and COGS, use 85%. This formula can have a tremendous impact on the overall goal.
The next step is multiplying each segment’s revenue percentage (refer to your P&L statement) by the COGS percentage from each segment above. What you get for each revenue segment is the COGS percentage goal as a percentage of total practice revenue.
Then, add up everything to arrive at your practice-specific COGS percentage goal.
The last step is to compare your actual COGS percentage with the goal.
Perfect Pricing
What can you do if your COGS is too high? Have your prices kept pace with inflation over the past several years? Have you increased your prices annually by at least the change in the Consumer Price Index? Have you cold-called competing practices to check their prices on commonly shopped services? You have a pricing issue if you don’t answer those questions with an emphatic “Yes!” Addressing it is likely your most impactful step to bring your COGS closer to the goal and improve your practice’s profitability.
Missed Charges
Audit your records to confirm that all services and products are invoiced. Emerging artificial intelligence solutions promise to help you track missed charges.
Discounting
I don’t say, “Never discount.” However, I recommend looking at all your discounts to ensure they align with your goals. Use them sparingly and with purpose.
Purchasing
New technology and services can price-shop within seconds. Such an amazing development can save your practice a significant amount of money. Balance it with vendor rebates to help keep your COGS as low as possible. Also, negotiate long-term contracts aggressively.
Inventory Management
I saved the best for last. If your practice management software cannot print an accurate inventory report, you are not managing your inventory well. That can lead to products walking out the front and back doors. It also indicates poor management oversight.
STORY ARCHIVE
Tens of thousands of dollars likely go uncollected each year at your practice. Read “Don’t Misfire on Missed Charges” at go.navc.com/missed-charges-TVB.