Indirect Costs and How They Affect Your Hospital

Many times when we think about the costs of a hospital, we think about the direct costs. The cost of a medication, a piece of equipment, the shipping costs, etc. We only think about how much an item costs and not necessarily the other costs that are associated with ordering and dispensing. But, there are other costs involved than just the cost of the medication or piece of equipment. These costs are called indirect costs, and if left unchecked can eat away at the profit margin very quickly.

So what are these indirect costs I speak of? Think about costs associated with ordering; your time creating a purchase order, placing the order, unpacking the boxes, receiving the purchase orders in the practice management system, paying the invoice, reconciling the statement, and so forth. These are called ordering costs. There are several more categories of indirect costs to keep in mind. These can include:

  • Holding Cost
  • Shrinkage
  • Shortage
Inventory Efficiency

The holding cost is the cost associated with unsold inventory and is a component of the total inventory cost. It can include the cost of storage, the labor involved with keeping items on the shelf (costs to count, monitor, rotate, etc.), and the cost of insurance. Shrinkage includes any amount of waste, damage, or theft. The waste of a product could be as a result of over-ordering due to miscalculation or expiration of a product. There also is a cost associated with shortages (or out of stock items). Think about the panic that ensues when a medication is out of stock… meltdowns of epic proportions. Then, someone has to run and grab something from another hospital (or pharmacy), doctors are running trying to find what they want to use as an alternative, they are writing scripts, and pulling out the Plumb. That whole situation is something we want to avoid. (Want to know more about how to avoid out-of-stocks, read our post on how to set up reorder points).

So you can see the extensive indirect costs that can quickly add up in addition to product cost. This is why it is imperative that our efforts related to indirect costs are as efficient as possible.

Think about a couple of scenarios. We think about price comparison to be important, it certainly can be to ensure you are getting the best cost. But, when you are price checking, does spending an extra 30 minutes to an hour to save a couple dollars really add up? Are we truly saving money if our labor costs are increasing? Think about big sales. If we stock up on a product that will be sitting on the shelves for months at a time, are we truly saving money if we are increasing our holding, labor, and insurance costs?

Indirect costs

Indirect costs can account for:

  • Ordering Cost: 15% – 20% of the total unit cost
  • Holding Cost: 8% – 15% of the total unit cost
  • Combined, OC + HC = 25% – 40% ($0.25 – $0.40 of every dollar of unit cost)

If for any reason the costs are higher due to inefficiency or miscommunication, you can see how your profit margin can be decreased quickly. (Want more information about profit margin and markup percentage, check out this article HERE.)

Let’s look at the example of lower mark up items; food, sometimes flea/tick/or heartworm. Food, for example, should have a markup of 45%, and if the combined indirect costs are about 40% of the unit cost that only leaves a 5% profit margin. In a $30 bag of food, this only equals $1.50 profit. Now, let’s look at heartworm prevention. For example, if you had heartworm prevention set at an average mark up of 75%, but your indirect costs are upwards of 40%, that leaves you with only a 35% profit margin. If you sold a box of heartworm prevention for $70, that only leaves you with $6.13 profit.

Especially for lower markup items, it is imperative that ordering and inventory are well-managed. One of my favorite things is to look at efficiency and operations management. I am more than happy to answer any questions you may have, and see how we can streamline your inventory process. (Here is my contact information.)

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