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CALCULATING COGS

MONITOR YOUR OPTICAL SUCCESS WITH THIS MEASUREMENT

SALES FROM optical products account for as much as 55% to 60% of your total income. In order to achieve the maximum profit from these sales, it is imperative that the cost of goods sold (COGS) is monitored.

Frame inventory costs and optical lab fees represent the two largest components of COGS. Measuring and monitoring COGS is critical to ensure a prosperous practice.

HOW TO CALCULATE

COGS should be calculated every month. To do so, first add all the month-end frame and optical lab invoices. Depending on the accounting method you use, this calculation will vary. In the accrual method of accounting, you would simply add all the invoices, regardless of whether they have been paid or not. If you use the cash method of accounting, you would only add those invoices paid during the month. If you are unsure of which accounting system you use, check your financial statements from your accountant.

Next, identify all other costs associated with the sales of optical goods. Typically, this would be the staffing cost. Calculate the salary and benefits paid to the optical staff during the period.

To determine the COGS, simply add these two values together. This value is then compared with the total adjusted gross revenue. Again, identifying the accounting method used is critical in ensuring that the COGS calculation is accurate.

The final step is to divide the COGS by the total adjusted gross revenue to determine the percentage of COGS to adjusted gross revenue. Calculation of the COGS as a percentage allows you to properly evaluate trends. One would assume that if total revenues increase, then COGS should increase as well. However, the percent relationship between the two values should remain fairly static, ideally 25% to 28%.

STEPS TO FIX

If the COGS is steadily increasing or is above 28%, corrective actions should be explored. There are two ways to reduce the cost of goods percentage: (1) increase revenues or (2) decrease expenses. For #2:

• Evaluate frame purchasing. Be sure that the size of the inventory as well as selection matches your patient demographics. Limiting the number of frame vendors will allow larger inventory purchases with better discounts, which can decrease your expense.

• Review your pricing with the optical labs. Often times, lab pricing can creep up, ultimately lowering your net profit on each sale if you don’t change your pricing strategy to reflect the change.

• Consider joining a “buying group.” Although there is often a fee attached to joining such a group, the cost savings your practice will obtain will likely far exceed the fee. Investigate the different buying groups, and pick the best match for your practice.

• Review your pricing. At least twice a year, review your pricing strategies. As more products are introduced into the market, be sure that you have properly positioned the product in your practice as well as set a “reasonable” fee.

CAREFUL MONITORING

COGS is often the largest expense category and, therefore, has the greatest impact on the net income derived by the practice. Careful monitoring will pay dividends by increasing your net income. OM

DAVID MILLS, O.D., M.B.A. practices at Ocean State Eye Care in Warwick, R.I., and holds an M.B.A. from Providence College. Email him at millsd@neco.edu, or visit tinyurl.com/OMcomment to comment on this article.