Pharmacy update: Understanding pharmacy finance

Understanding the financial elements of operating a pharmacy is key to its success and profitability, so it is vital to get it right.

Gross profit

The gross profit margin for pharmacies is the profit on the sale of products, dispensing and delivering services. The profit is typically calculated before taking into account any wages and salaries, locum costs, administrative expenses, interest and tax.

The gross profit margin is normally expressed as a percentage (GP%), and this percentage will typically vary between pharmacies depending on a variety of factors such as:

• Sales mix between NHS dispensing and retail/OTC sales
• The number of services performed
• Dispensing mix of the pharmacy
• The mark up applied to retail and OTC sales
• The prices obtained from suppliers
• Control over buying processes
• Stock management

The GP% is calculated by dividing the gross profit by the turnover – the gross profit being the turnover minus the cost of sales. In order to compare it between pharmacies, it is important to be consistent with what is included in turnover and cost of sales.

It is expected that the mix of turnover will vary more in the next few years, as pharmacies deliver different services to maintain and increase their profits.

Therefore, if a pharmacy is trying to calculate their GP% it is advised to breakdown the turnover as much as possible into the different categories, to ensure the end result is a comparable figure between pharmacies.

When calculating the gross profit, turnover should not include:

• Rebates and discounts from suppliers (but these should be included in purchases as a negative amount)
• Wholesale turnover (as not all pharmacies will sell to the wholesale market)
• One-off/exceptional income and any associated costs

What is included in cost of sales will vary between different sectors. For pharmacies, cost of sales should only include the cost of buying the products to either dispense or sell over the counter. It should not include wage, salaries, locum costs or any costs in relation to wholesale sales.

We have considered below some potential ways to improve the gross profit margin:

1. Review the purchase prices from suppliers on a regular basis and try to obtain a net price from the supplier (i.e. after discounts and rebates)
2. Review stock levels and usage level before buying
3. Ensure staff are following the buying procedures set out and are not bypassing the system
4. Check prices with a number of suppliers as much as possible, especially where the stock item is in short supply

EBITDA

One of the key financial measures to consider when acquiring a pharmacy is the earnings before interest tax depreciation and amortisation, which is shortened to EBITDA.

The EBITDA shows the basic cash flow generated from the pharmacy on trading activities and is essential for funding and comparing a pharmacy performance. When acquiring a pharmacy, it is essential to calculate the EBITDA, as in general the value is calculated based on a multiple of EBITDA.

A basic EBITDA is calculated by using the profit after tax figure and adding interest paid, any corporation tax that has been charged in the profit and loss account, depreciation, and amortisation. Additionally, any interest received must also be deducted. All of these figures are available in the financial statements of the pharmacy.

To enable a direct comparison to other pharmacies you should also adjust the following:

1. Market rate for the owner managed time
2. Market rate for rent when the premises is not leased from a third party
3. Removal of any non-recurring income and expenses

The calculation of EBITDA has become more complicated following the COVID-19 period as there are income streams and expenses that have impacted the normal run rate of the pharmacy. We have seen EBITDA figures rise in 2021 and subsequently fall in 2022 and therefore it is vital to obtain the most recent trading figures and normalise the EBITDA.

Some of the more common issues are listed below:

1. COVID-19 retail and hospital leisure grant – The £10,000or £25,000 should be deducted from the EBITDA as this is one-off income.
2. Rates relief – rates cost should be normalised
3. COVID-19 vaccination centre income and expenditure
4. COVID-19 testing kits
5. COVID-19 delivery income
6. COVID-19 reimbursement of costs incurred

Staff costs

With staff costs increasing due to inflation and increased locum costs, we have seen staff costs as a percentage of turnover increase on average by 2% to 3%. Before we consider how you can improve the staff costs/staff retention of the pharmacy, it is important to understand what is included in the staff costs.

As mentioned above, the main key performance indicator (KPI) for the pharmacy sector is staff costs as a percentage of turno ver, which is calculated by dividing staff cost by turnover. It is important to remember that the turnover figure should not include any wholesale and non-recurring turnover as this may distort the overall calculation.

Staff costs can be quite varied for a pha rmacy, depending on turnover, staff requirements/structure and availability of pharmacy staff in a certain area. These costs include not only employed staff, but also locum costs, staff training, staff pensions and staff welfare.

Since the structure of staff costs can vary, adjustments to staff costs may be needed (such as owner’s imputed salary) before these costs can be compared costs with another pharmacy. You should only compare pharmacies with a similar turnover level and working hours.

Pharmacy owners should include a market rate cost for their time, whether they work as a pharmacist or another role in the pharmacy. The costs should only include time a normal employee would cover (i.e. if you spend time on administration matters such as finance, this time should not be included).

If a pharmacy is using the staff costs directly from their financial statements, any costs that are included in relation to the owner must be removed, such as director salary and pension, and replaced with the market rate for their time.

In order to assess staff costs for a pharmacy, there are a number of things that can be done:

• Reviewing staff working hours to ensure you have the right number of staff at the appropriate time.
• Assessing if when there are quieter times during the day for certain staff, work can be transferred to these staff.
• Reviewing the work currently being performed by staff and whether the role they are currently performing is in line with the level of skill and experience.
• Ensuring the pharmacist is delegating as much as possible in order to free up their time to perform other services.
• Ensuring locums and employed pharmacist perform services as the cost of say performing one NMS in an hour will help cover their cost.

For more information on pharmacy finance, watch our short webinar series or contact Richard Medes on richard.medes@hazlewoods.co.uk or 01242 680000.