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FUNDAMENTALS OF PURCHASING AND INVENTORY

CONTROL FOR CERTIFED PHARMACY TECHNICIANS

By
Jeff Blackburn, C.Ph.T., MBA Healthcare Administration

OBJECTIVES
At the end of this course, the reader should be able to meet the following objectives:
1. Discuss why inventory control is important for pharmacies.
2. Understand the objectives of inventory control within a pharmacy.
3. Become familiar with some of the more common purchasing concepts.
4. Become familiar with some of the methods for controlling inventory.
5. Discuss purchasing policies and their value within the pharmacy.
6. Discuss some of the different models for inventory control.
7. Having a working knowledge of some of the most common receiving and
storage
policies.

WHY INVENTORY CONTROL IS IMPORTANT?
Among the many pharmacy management functions performed in a pharmacy,
few have more direct impact than purchasing policies and inventory control. Sound
purchasing and inventory control are closely interrelated because one cannot be
effective without the other. Purchasing requires knowing the right quality and quantity
to buy, when to order, at what price, and from what sources. Inventory is simply the
result of this buying.
Some kind of inventory control system is essential to carry out the purchasing function
effectively. For example, one must know how much of a given item is in stock at a
given time in order to decide whether it is time to reorder.
A pharmacys inventory represents its single, largest investment. Consequently,
no other asset has the potential to devastate a pharmacy as much as poorly controlled
inventory. In an average pharmacy, cost of goods sold account for approximately 68%
of total expenditures. For every 1% change in an average pharmacys costs of goods,
profits may increase or decrease by slightly more than 20%. Thus, the sheer magnitude
of dollars involved make seemingly minor inefficiencies in purchasing and inventory
control matters of great importance to both cash flow and profitability.
Despite the highly visible nature of purchasing and inventory control, they
seldom are given the quality of attention they deserve. As a daily activity, purchasing
commonly is viewed more as a routine buying process than an investment process
with far-reaching consequences. And the mundane nature of inventory control makes
it one of the more frequently deferred activities of pharmacy technicians. Ironically,
the sophisticated and efficient purchasing programs offered by many wholesaler
suppliers have perhaps contributed to the lack of attention.
Supplier systems are designed to relieve the time-consuming but routine
aspects of purchasing and inventory control, while simultaneously providing valuable
data to help make more knowledgeable purchasing and inventory control decisions.
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Unfortunately, many pharmacies see these systems as vehicles for minimizing
the time spent on the whole realm of purchasing and inventory control rather than a
way to reallocate time to their more fundamental responsibilities.

INTRODUCTION
The objective of an inventory control system is to make inventory decisions
that minimize the total cost of inventory. This is not to be confused with minimizing
inventory. It is often more expensive in a pharmacy to run out of an item than to
simply keep more units in stock. For example, in a retail pharmacy, if a customer is
unable to obtain their medication, they may go somewhere else and the pharmacy
may lose future purchases. In a hospital pharmacy, if you run out of an item, you might
be required to obtain it by a more expensive method (over-night delivery, hot-shot,
ect.).
Most pharmacy inventory decisions involve replenishment how much to
order and when to order. In this course we will look at several models for minimizing
the total cost of inventory, including the popular method of Economic Order Quantity
(EOQ). This particular method attempts to balance the carrying cost inventory with the
cost of running out. As we look at each of the inventory control models, it is important
to keep in mind the different types of cost associated with pharmacy inventory:

(1) carrying costs,
(2) shortage costs, and
(3) replenishment costs.
Each of these costs is discussed later in the course.

Many of the models we will discuss make certain assumptions that do not hold
within the operations of a hospital pharmacy. For instance, the costs associated with
running out of a drug product used in critical care might involve increased morbidity
and mortality, which is not an acceptable situation. Given that, the basic concepts of
these inventory control models can be applied to hospital pharmacies when
appropriate.

INVENTORY CONTROL
Inventory control is the process of managing inventory in order to meet
customer demand at the lowest possible cost and with a minimum of investment.
Unlike many factors in pharmacy, inventory is controllable. The pharmacy decides how
much inventory investment to make, when to reorder, and in what quantities.
A successfully implemented inventory control program takes into account such
things as purchasing goods commensurate with demand, seasonal variation, changing
usage patterns, and monitoring for pilferage. The challenge of productive inventory
management is to support an upward trend in sales while keeping the investment at
the lowest level consistent with adequate customer service.
There are several objectives of inventory control:
Minimization of the inventory investment.
Determination of the right level of customer service.
Balance of supply and demand.
Minimization of procurement costs and carrying costs.
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Maintenance of an up-to-date inventory control system.
Unfortunately, it may be impossible to achieve these objectives concurrently. For
example, to best satisfy the needs of patients, a pharmacy may have to carry a wide
range of both prescription items and front-end merchandise. In a hospital pharmacy,
prescribers may want the pharmacy to stock several therapeutically equivalent drugs.
This cannot be achieved by minimizing inventory investment. This is one of the
contradictory demands made upon the inventory control system. Other include:
1. Maintaining a wide assortment of stock but one should not be spread
too thin on the rapidly moving ones.
2. Increasing the inventory turnover but one should not sacrifice service
level.
3. Keeping stock low but one should not sacrifice service or perfor-
mance.
4. Obtaining lower prices by making volume purchases but one should
not end up with slow moving inventory.
5. Having an adequate inventory on hand but one should not get caught
with obsolete items.
Successful inventory management involves simultaneously attempting to
balance the
cost of inventory with the benefits of inventory.

What to Control
Despite the importance of inventory control in the overall management of a
pharmacys assets, there is no denying that this activity can be time-consuming
andexpensive. And it is not uncommon to find even the most adamant supporters of
inventory control spending more for control than they would lose by having a less
efficient system. Normally, however, it is more likely that inventory is not being
controlled to the extent that it should, and money is being lost.
A preliminary step in the process of inventory control is to determine the
approximate costs of carrying inventory. These costs include such expenses as storage
costs, inventory risks, and the loss-of-opportunity costs associated with tying up
capital.
Obviously, many of these costs are difficult to determine precisely.
Nevertheless, it is possible to approximate most of these for decision making purposes.
The costs of capital and opportunity are the most important of those associated with
holding inventory. By investing in inventory, other uses for money are lost uses
which could provide greater returns. The most commonly used benchmark for
measuring the costs of capital is the prevailing interest rates. Ideally, this measure
should be for an investment of comparable risk, but that is seldom possible.
Consequently, some nearly risk-free investments, such as treasury bills, are often used
instead.
Closely related to the costs of capital are the opportunity costs of using space
for one type of product rather than another. At times the difference between these
costs may appear insignificant. Yet, the costs of capital represent the fundamental
decision as to whether to invest in inventory, while the opportunity costs concern
what types of inventory are held.
Irrespective of what the actual costs are of holding specific items in inventory,
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there is little doubt that some items need to be controlled more than others. Some
cost
more, and therefore represent a greater financial investment. Some are dated and
have
only a relatively short shelf life, and others may be important for other reasons (such
as critical life-saving drugs used in a hospital).


PURCHASING CONCEPTS
Now that we have identified what and why of inventory control. We should
take a look at a few of the concepts surrounding purchasing.

ABC Classification System
The ABC classification system groups items according to annual sales volume, in
an attempt to identify the small number of items that will account for most of the sales
volume and that are the most import ones to control for effective inventory
management.
In this system, inventory can be labeled as being A, B, or C products. This gives
recognition to the varying importance of different types of pharmacy inventory.
Consequently, classifying merchandise into A, B, and C items allow the pharmacy to
better identify and control items of greater importance. For example, approximately
20% of the inventory items should receive much greater attention than the remaining
80% since they may account for 90% or more of inventory investment. Loss of control
over a few of these items is considerably more serious than loss of control over a large
number of other items.

Table 1
Typical ABC Classification System
Class
% of Dollars

A 70 80
B 15
C 5 10


A items would be considered the most important to control, where as C items would
be considered the least important to control, and not worthy of the more elaborate
system used to control A items. B items would be somewhere in the middle and their
control would depend on the actual cost of inventory control.

Lead Time
The Lead Time is the interval between placing an order and having it ready for
dispensing. When calculating lead times in a pharmacy, you must consider the amount
of time to stock the shelves, compound, or mix.

Safety Stock
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Safety stock is the extra units of inventory carried as protection against possible
stock-outs. The safety stock must be carried when the pharmacy is not sure about
either the demand for the drug or the lead time or both. In the case where the
demand is uncertain, safety stock is the difference between the maximum usage and
the average usage multiplied by the lead time. For example, assume that a pharmacy is
faced with an uncertain usage of Lisinopril. Lead time is constant at two days. Normal
daily usage is 7 bottles but it can go as high as 10. The store would compute the safety
stock as follows:



Maximum daily usage: 10 bottles
Average daily usage: 7 bottles
Excess : 3 bottles
Lead time x 2 days
Safety Stock: 6 bottles


Reorder Point
The reorder point is the inventory level at which it is appropriate to replenish
stock. The calculation is as follows:

Reorder Point = Average Usage Per Unit X Lead time + Safety Stock

First, multiply average daily (or weekly) usage by the lead time in days (or weeks)
yielding the lead time demand. Then add safety stock to this to provide for the
variation in lead time demands to determine the reorder point. If average usage and
lead time are both certain, no safety stock is necessary and should be dropped from
the formula.
Example:
Demand = 1,000 vials per year
Store open = 311 days/year
Daily demand = 1,000/311 = 3.2154 vials per day
Lead Time = 2 Days
R = dL = (3.2154)(2) = 6.43 rd, 7 vials per day

Inventory Turnover Rate
One method of assessing the effectiveness of an inventory control system is the
turnover rate. The inventory turnover rate represents the average number of time the
inventory is sold and placed during a given period (usually a year). In general, a high
turnover rate indicates that product usage is good relative to the average amount of
inventory kept in stock. A low turnover rate indicates that products are not being used
at a proper rate relative to average inventory.
Inventory turnover rate is calculated by dividing the inventory cost into annual
purchases. The average pharmacys inventory turnover rate does not exceed 10 turns.
Most pharmacies average between 8-10 turns per year. A pharmacy purchasing $100K
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per month will save $20,000 in on-hand investment dollars (or cash flow savings) with
each single digit increase in the inventory turnover rate.
Example:

Inventory Turnover Rate =



=


= 8 inventory turns per year

An increase form 8 to 9 turns will drop the average on-hand inventory from $150,000
to $130,000 or a cash flow savings of $20,000.





A pharmacy that purchases $50,000 per month or $600,000 per year in purchases
will save $10,000 for each single digit increase in inventory turns.
This reduction in the on-hand inventory investment is the equivalent of an interest free
loan to the pharmacy.

The Economic Order Quantity
One of the best known models for inventory control is the economic order
quantity (EOQ). The purpose of this model is to answer two important questions:

(1) When should an item be reordered (resulting in replenishment cost), and
(2) What quantity should be ordered (resulting in carrying cost)? The model
can thus be used to determine how much inventory needs to be carried to
meet demand, but not so much that excess costs are incurred.
(3)
Procurement costs (replenishment costs) include costs of making requisitions, writing
orders, receiving and inspecting goods, completing the purchase transaction, and
maintaining inventory records. These costs are normally fixed, regardless of the size of
the order.

Carry costs include such items as interest, insurance, taxes, deterioration, spoilage,
obsolescence, handling, and warehousing. Interest payments in particular can be
major cost items if the inventory stock has large sums of money tied up in it. Because a
significant portion of a pharmacys working capital is tied up in inventory, a small
reduction in inventory investment may result in a significant increase in working capital
and reduce the amount of money needed to borrow. Even if a pharmacy does not
borrow to finance its inventory, it would be advantageous to reduce inventory levels
since the money can be invested elsewhere.
Annual purchases at cost
Avg. On-hand Inventory
$1,200,000 ($100K X 12)

$150,000

= 9.2 inventory turns per year

$1,200,000

$130,000

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We will take a deeper look at these costs a little later in the course.
The EOQ model is based on three basic assumptions:
(1) the firm knows with certainty the annual usage of a particular item of
inventory;
(2) the rate of usage of inventory does not vary over time; and
(3) orders placed to replenish the inventory are received at exactly the point in
time when inventory is zero.
These highly restrictive assumptions greatly limit the usefulness of the EOQ formula. A
useful feature of themodel is its determination of a basic optimal reorder quantity that
the inventory manager
may adjust according to his or her personal knowledge of demand fluctuations,
delivery delays, and other variables.

What Does Inventory Actually Cost

Carrying Costs (K Cost)
The carrying cost of inventory is the cost of maintaining your average inventory
investment of inventory in your pharmacy. What costs do you incur in carrying
inventory?
1. Cost of putting away stock receipts and moving materials within the
pharmacy. In other words, the cost of paying someone to do these
activities.
2. Rent and utilities for the portion of the pharmacy used to store inventory.
3. Insurance and taxes on inventory. You have to insure your inventory and
except for tax exempt hospitals, it will probably be subject to taxes.
4. Physical inventory and cycle counting (discussed later).
5. Inventory shrinkage and obsolescence. Most drugs have an expiration date.
6. Opportunity cost of the money invested in inventory. What could you be
doing with the money you have invested in the inventory? For example, in a
retail pharmacy you could spend more on advertising. In a hospital
pharmacy you might use that money for added services.

The carrying cost percentage is calculated by dividing the sum of these
expenses (along with opportunity cost) by the average inventory value. It is the
amount of money it takes to maintain on dollars worth of inventory for an entire year.
To calculate the carrying cost in your pharmacy, you must answer the following
questions:
1. What was the average inventory value over the past 12 months (sum of
monthending inventory values divided by 12)?
2. What was your total labor expense (wages, taxes, and benefits) during
the past 12 months (including the expense of inspections, putting away
the stock, moving from bin to bin as necessary)?1
3. How many square feet in your facility?
4. How many square feet in the pharmacy?
5. What were the utilities over the last 12 months?
6. What was the value of written-off inventory last year? (expired or
unusable meds)
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7. What was the value of inventory shrinkage last year?
8. How much of the current inventory is in excess of a 12-month supply (a
value equal to monthly demand x 12)?
9. What was the cost of insuring your inventory?
10. What was the cost of inventory taxes last year?
11. If additional labor was necessary to conduct physical counts of your
inventory, what was the cost of this labor (including taxes and
benefits)?
12. If you borrow money to finance your inventory, what was the average
outstanding balance over the past 12 months? What was the annual
interest rate?
13. If you paid cash for your inventory purchases, what interest rate could
you expect to receive if you invested that money in a relatively safe
income-producing investment?
Determining your pharmacys actual carrying cost is very difficult to do in a
reasonable amount of time. For this reason, you might find it more reasonable to use a
rule of thumb such as current prime rate plus 20%.
1 Some pharmacies will also include the cost of compounding and IV admixture.

While you may not have the time to calculate your exact carrying costs, you should
be aware that they exist. The economic order quantity formula is designed to calculate
the lowest total cost reorder quantity based, in part, on the cost of carrying inventory.
If it costs you less to maintain inventory in your warehouse, you will tend to stock
more. If your carrying costs are high, you will probably want to keep just enough
inventory in your pharmacy to protect customer service.

Shortage Cost
The shortage cost is what is lost if the stock is insufficient to meet all demand.
This cost can be the most difficult to measure and is often handled by establishing a
service level policy. For example, a certain percentage of demand will be kept in
reserve or safety stock. One of the methods evaluated for computing shortage costs
is based on the items average acquisition price, since this is the minimum measure of
how much a pharmacy is willing to spend to avoid a shortage. Shortage costs are also
computed using the cost to operate a pharmacy. This method is based on the
assumption that the value of a pharmacys capabilities is equivalent to the amount of
money the pharmacy is willing to spend to operate. There are several other
mathematically intensive, time weighted methods for calculating these costs, but the
point to remember is there is a cost for running out of items in your pharmacy and you
should consider those costs as you seek to control your inventory.

Replenishment Cost (R Cost)
The replenishment cost is the cost of issuing, receiving and paying for a line
item on a vendor purchase order. The cost of reordering inventory (also known as the
R Cost) includes:
Deciding what products need to be replenished
Issuing the purchase order
Expediting the purchase order (if necessary)
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Processing the receiving paperwork for shipment
Approving the vendor invoice for payment
Processing the vendors payment
The cost of reordering is calculated by dividing the total annual cost of
purchasing stock line items by the number of purchase order line items for stock
products issued by the past year:





Note that the cost of reordering is not calculated for a whole purchase order or
each piece purchased. The R cost is expressed per purchase order line item. The theory
is that it probably takes the same amount of time and effort to purchase a product
regardless of whether you by 10, 50, or 1,000 pieces. Even so, the cost per piece drops
rapidly as the quantity purchased increases. For example, if the cost of reordering is
$5.00 per line item and we buy one piece, that one piece has to absorb the entire $5
R Cost. But if five pieces are ordered, each piece only has to absorb $1 of the $5 R Cost.

Methods for Controlling Inventory
There are various methods for controlling inventory and each has advantages
and disadvantages. The open-to-buy (OTB) budget method limits purchases to a
specific amount of funds available for purchasing pharmaceuticals during a specified
period. The emphasis of the OTB method is financial control of the pharmacy
inventory. Although it is useful in monitoring and adjusting the dollar value of the
inventory, it should be combined with other methods for a total inventory control
system.
The primary emphasis of the short-list method is to provide accurate and
timely inventory information to the person responsible for order placement. The short
list identifies the items that are in short supply. It is the most common feedback and
control mechanism in use, but it is best suited for settings where duplicate or reserve
stock is maintained and monitored by more rigorous methods.
The main objective of the minimum and maximum method is to determine
when and how much to order of each item. It also provides limited dollar control. The
major disadvantage of this method is the time it requires to establish the minimum
and
maximum levels and to update them regularly to reflect changes in demand.
The stock record card method is used to record information on the movement
of goods in and out of the storage area. Stock cards can also be used to monitor
inventory levels and facilitate order initiation. It is probably the optimum method to be
used alone. The most effective system of inventory control is one employing a
combination of these methods tailored to meet the institution's needs and available
resources.

Purchasing Policies
Annual Cost of Issuing Purchase Order Line Items
Purchase Order Line Items Issued in the Past Year

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Purchasing policies should be flexible and reflect the pharmacys objectives and
plans. They must leave room for discretion to allow the pharmacy to respond to
unanticipated events such as unusual demand fluctuations and special price incentives
offered by suppliers.
When developing a purchasing policy, it might be helpful to consider the
questions in Table 1-1.

Table 1-1

Assessing Purchasing Policies and Procedures

Have you ever reviewed existing purchasing procedures to see if they meet your
needs?
Do you have specific policies and procedures regarding who is authorized to
purchase goods or services? Receive salespersons calls? Place requisitions?
Process records?
Have you ever discussed your purchasing function with other pharmacies or with
professional organizations to obtain suggestions or techniques?
Have you ever visited or investigated your existing or potential vendors to verify
that they can meet your requirements in terms of price, quality, quantity, and
service?
Does your volume of purchasing for any particular item warrant your dealing
directly with its manufacturer?
Do your vendors have regular and competent sales personnel?
Have you had problems with suppliers in regard to shortages? Backdoor selling?
Delivery delays? Unsolicited favors and gifts?



Selecting Vendors
The objective of careful vendor selection is to find the one most satisfactory
source, or a number of alternative sources with adequate comparable qualifications.
Thus succeeding orders for the same item can be placed with these same suppliers
with confidence in the original selection. In other words, the decision as to a source of
supply contemplates a continuing relationship.
Several criteria should be considered in selecting vendor sources, including:
Reliability. Will the vendor fulfill all promises?
Price and quality. Who provides the best product at the lowest price?
Order-processing time. How fast will a delivery be made?
Functions provided. Will the vendor provide storage, market information, and
other functions, if needed?
Guarantee. Does the vendor stand behind the products?
Financing. Does the vendor provide credit?
Long-run relations. Will the vendor be available over an extended period of
time?
Innovativeness? Are the vendors product lines innovative?
Risk. How much risk is involved in dealing with the vendor?
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Investment? How large are total investment costs?
The real test of vendor selection is the test of experience, or satisfactory
performance by the vendor once the order has been placed.

Working With Wholesalers
Selecting and working with capable wholesalers is a significant function of
purchasing. Probably no one is more important to the operation of a pharmacy than
the wholesaler. Yet many pharmacies have not recognized that good supplier
relationships result in wholesaler goodwill. Instead, wholesalers are often treated in a
suspicious and even ill-mannered fashion. It is mutually advantageous to have a
positive buyer-seller relationship. There have been numerous instances when an
unexpected problem or emergency was solved with the help of a friendly wholesaler.
The question of how many wholesalers to use has no definitive answer. It
depends on many factors. Many buyers have found it advantageous to spread
purchases among many wholesalers to gain the advantage of the most favorable prices
and best delivery schedules. Another reason for relying on several wholesalers is that it
gives buyers an opportunity to continually evaluate alternative sources of supply, to
have greater assurance of supply reliability, and to keep wholesalers competitive with
one another.
On the other hand, several distinct advantages of concentrating purchases from
one wholesaler can also be cited. For example, the argument for doing the bulk of
buying from a single wholesaler is that in times of shortages, the primary vendor will
take better care of its customers. Other possible advantages include receiving more
attention and help from a wholesaler who know it is receiving most of the pharmacys
business; having a smaller inventory investment; having larger purchase orders; which
may permit larger discounts; and simplifying credit problems. These advantages are
convincing arguments as to why it is often better for a pharmacy as to why it is often
better for a pharmacy to concentrate its purchases and work closely with a few
wholesalers.
Purchasing policy in most pharmacies traditionally requires at least two supply
sources for each item as being in the best interest of the company.
Whether there should be more than two, and how many, is a matter of purchasing
judgment. It depend partly on the importance of the item, on competitive conditions
in the industry, and on the quantities involved, which might make it practical to divide
the business among several vendors.

Purchase Timing Decision
Decisions concerning the timing of purchases must closely coincide with
demand and minimize the amount of inventory investment. One means of doing this is
to establish stock levels at which new orders must be placed. The stock levels are
called reorder points. Determining reorder points depends on the length of order lead
time, usage rate, and the amount of safety stock to be kept on hand. Order lead time is
the time span from the date an order is placed to the date the merchandise is received
and put on the shelf. Usage rate refers to average usage per day, in units. Safety stock
is the amount of extra inventory kept on hand to protect against running out of stock
owing to unexpected demand and delays in delivery. Safety stock should be planned in
accordance with the pharmacys policy toward running out of merchandise. The
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formula for when to reorder, assuming the pharmacy incorporates safety stock into its
planning, is:

Reorder point = (usage rate x lead time) + safety stock

Ideally, orders should be placed at the precise point in time at which usage
during the order lead time will have depleted the inventory on hand, so that no safety
stock is needed. Unfortunately, ideal conditions seldom, if ever occur.
To establish effective safety stock policies, it is necessary to make a trade-off
between two opposing factors: the cost of carrying safety stock and the cost of being
out of stock. Normally, inventory carrying cost is easier to measure than the cost of
running out of inventory. It includes:
(1) capital costs (inventory investment and investment in assets required by
inventory),
(2) inventory service costs (insurance and taxes),
(3) storage space cost (warehousing costs), and
(4) inventory risk costs (obsolescence, damage, pilferage).
Out-of-stock costs are the costs incurred by the pharmacy when an item is
demanded but is not immediately available. The cost of a stock-out is determined by
the reaction of the customer (patients, prescribers).
Another dimension of the timing issue in purchasing is whether buying will be
conducted at random points in time or restricted to defined periods. Left unrestricted,
purchasing can become a daily activity conducted in bits and pieces, and hurriedly on a
time-available basis. As such, purchasing control tends not to be very stringent, as no
consideration is given to monetary investments in inventory or the trade-offs in the
use of limited purchasing dollars.

Purchase Terms Decisions
Pharmacies must negotiate the best deal they can with each supplier to
improve profit. Five factors are especially important in supplier negotiations:
(1) quantity discounts,
(2) cash discounts,
(3) trade discounts,
(4) promotional discounts, and
(5) return goods policies.
Unfortunately, not all deals may be worthwhile. The quality of a cash or
quantity discount, for example, depends on the amount of discount being offered, the
carrying cost of holding inventory, the price charged for the item, and the time it takes
to turn the merchandise into sales. Most important, a deal can only be profitable when
the sale, not the purchase, is completed. Thus, a 25% discount on an item that will not
be used is notmuch of a deal. On the other hand, a 1% discount on merchandise that is
sold and replaced weekly may represent a very good deal for the pharmacy.
Quantity Discounts are reductions in price allowed for buying certain quantities.
They are generally expressed in terms of total dollars purchased. Another variation of
quantity discounts is cumulative discounts. They represent discounts calculated at the
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end of specified time periods. For example, a 10% discount may be offered if a
pharmacys purchases total over a certain dollar amount. These discounts tend to build
loyalty to a single supplier.
The disadvantages of taking quantity discounts, however, must be considered.
Larger purchases increase the risks of loss resulting obsolete products expired
because it could not be sold with reasonable speed. Additionally, large purchases serve
to increase the dollar investment in inventory. If the pharmacy faces cash flow
problems, these can be critical problems.

Deciding on Models of Inventory Control
Although inventory control systems can and should be developed to suit the
specific needs of a particular pharmacy, they can be conveniently classified as being
visual, periodic, or perpetual systems. Each can be used effectively in a pharmacy,
depending on the particular situation.

Visual System
The least expensive and generally the least effective system of inventory
control is the visual system. With this system, one simply looks at the number of units
in inventory and compares them with a listing of how many should be carried in stock.
Shelf stickers can be coded for this to make the process easier. When the stock
on hand falls below the number desired, an order for more merchandise is placed.
Generally, this type of system is used for the less expensive and least important items
in the pharmacy, i.e., the C items referred to earlier.
The primary advantages of the visual system of inventory control are that it is
relatively inexpensive, takes little time, and does not have to be conducted by
personnel who have special skills. Often lacking the formality of other systems, visual
inspections can be made when convenient and in very short periods of time, thereby
keeping the costs very low.
Despite theses advantages, there are some serious drawbacks to the use of a
visual system. Because of its tendency to informality, the system is not used as
frequently or with the precision it requires. Perhaps even more important, visual
systems commonly focus on impending stock-outs rather than on excess inventory. It
is much easier to spot empty places on the shelves, than it is to identify slow-moving
merchandise or excess inventory. Furthermore, visual systems focus on unit levels
only. They do not consider dollar investments in inventory.
However, even with these potential problems, this system is commonly used in
pharmacies since technicians use the stock and thereby conduct visual inspections
frequently. Furthermore, replacement stock typically can be obtained quickly. So long
as the inventory manager reevaluates minimum quantity levels with reasonable
frequency and determines EOQs in advance, this system is a low-cost, somewhat
trouble-free means of keeping loose control over some inventory. Nevertheless, it
ordinarily will not provide sophisticated controls or produce data necessary for optimal
efficiency.

Periodic System
A more elaborate means of inventory control is through a periodic system.
With this inventory control process, as its name suggests, stock on hand is counted at
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predetermined intervals and compared to the minimum desired levels. If the stock is
below the minimum desired, an order is placed. Evaluation of inventory levels is made
on a more formal basis than with a visual system, so the system tends to be more
precise.
Additionally, stock control cards (or stock record cards) are sometimes used to
keep records on how many units have been used and how many are on order. With
this system, then, analysis can be made of fast- vs. slow-moving items, and the dollar
investment in inventory. Accordingly, it tends to be much better than visual systems
for control of more important inventory when conducted at least semiannually. While
periodic systems are more accurate, they are also more expensive than visual systems,
and accordingly tend to be used mostly for B and sometimes A items.
Ordinarily, one will find periodic systems to be cost-justifiable. The most
serious limitation of such systems, however, is their measurement at a single point in
time. Thus, one could have significant variations in inventory levels which would not be
evident from a periodic audit. Additionally, the timing of review may affect inventory
levels, depending on how much usage fluctuates on a seasonal basis. Because of this,
some pharmacy owners use intermittent visual audits between more formal,
semiannual, periodic inventory audits.

Perpetual System
The most elaborate and accurate basic inventory control system is the
perpetual system. With this system, inventory is monitored at all times. In this way, it
is possible to determine at a moments notice how many units of each item are in
stock. This type of system provides the best opportunity to control both the number of
units and the dollar investment in inventory. Certainly, the greatest drawback of
perpetual systems is that they are the most expensive to maintain. Furthermore, they
generate inordinate amounts of data far more than one is likely to use. Some
pharmacies become overwhelmed by the mass of data that they tend to ignore the
data altogether.

RECEIVING AND STORING PHARMACEUTICALS
Receiving is one of the most important parts of the pharmacy operation. A
poorly organized and executed receiving system can put patients at risk and elevate
health care costs. For example, if the wrong concentration of a product was received in
error, it could lead to a dosing error or delays in patients receipt of therapy. Misplaced
products or products not in stock also jeopardizes the patients care and increases
health care costs.
To avoid these unfavorable outcomes, pharmacy technicians should become familiar
with the process for receiving and storing pharmaceuticals.


The Receiving Process
When orders arrive from either the manufacturer or the wholesaler, they
should be accompanied by either an invoice or a packing slip that lists what the
pharmacy is being charged for. As you remove the items from the box and place them
into inventory, it is critical that you check them against this list; otherwise, the
pharmacy may not receive everything it will be asked to pay for.
15

Also be sure to follow any internal pharmacy procedures concerning the receipt
of inventory. For instance, you may need to confirm receipt of the order in the
pharmacy computer system, either through manual entry or by bar-coding the
incoming items. Unless you let the computer know that the order has been received, it
will reflect an incorrect inventory level and may keep trying to order more product
even though an adequate amount is on hand.

The Storing Process
Once the product has been properly received it must be properly stored.
Depending on the size and type of pharmacy operation, the product may be placed in a
bulk, central storage area or into the active dispensing areas of the pharmacy. In any
case, the expiration date of the product should be compared with the products
currently in stock. Products already in stock that have expired should be removed.
Those products that will expire in the near future should be highlighted and
placed in the front of the shelf/bin. The newly acquired products will generally have
longer shelf lives and should be placed behind packages that will expire before them.
This technique is referred to as stock rotation. Stock rotation is an important inventory
management principle that encourages the use of products before they expire and
helps prevent the use of expired products.

Product Handling Considerations
Pharmacy technicians usually spend more time handling and preparing
medications than pharmacists. This presents pharmacy technicians with the critical
responsibility of assessing and evaluating each product from both a content and
labeling standpoint. It also provides the technician with an opportunity to confirm that
the receiving process was performed properly.
Since pharmacy technicians handle so many products each day, they are in a
perfect position to identify packaging and storage issues that could lead to errors. The
three main issues to pay close attention to are:
Look-alike Products. Stocking products of similar color, shape, and size could
result in error if someone fails to read the label. All staff members should be
alerted to look-alike products.
Misleading Labels. Sometimes the company name or logo is emphasized on
the label instead of the drug name, concentration, or strength.
Product Storage. Storing products that are similar in appearance adjacent to
one another can result in error if someone fails to read the label.
It is essential to alert other staff members to products that fall into one of
these categories.

Drug Recalls
Pharmaceuticals will occasionally be recalled by a manufacturer and/or the
Food and Drug Administration (FDA) for reasons such as mislabeling, contamination,
lack of potency, or other situations affecting the product as packaged or labeled. It is
imperative that a pharmacy have a system for a rapid removal of all products affected
by recalls.
Recall notices are sent in writing to pharmacies by the manufacturer of the
product or B drug wholesalers. These notices indicate the reason for the recall, the
16

name of the recalled product, and instructions on how to return the product to the
manufacturer. Upon receipt of the recall notice a pharmacy staff member, usually a
pharmacy technician, will check the pharmacy and the institution to determine if
recalled products are in stock. If none of the recalled products are in stock, a note
indicating none in stock is written on the recall notice and filed in a recall log to
document that the recall was properly addressed. If a recalled product is in stock, all
products should be gathered, packaged, and returned to the manufacturer according
to the instructions on the recall notice. The package should be reviewed by the
pharmacist in charge prior to sending it.
If patients have received a recalled product, the pharmacist in charge must take
the recommended action. Upon completion of all activity regarding the product recall,
a summary of actions taken should be written on the recall letter and filed in the
pharmaceutical recall log. Keep in mind that it may be necessary to order more stock
to compensate for those items that were recalled. In some instances, the recall may
encompass all products and it will not be possible to order replacement stock.

Controlled Substances
Controlled substances have specific ordering, receiving, storage, dispensing,
inventory, record keeping, return, waste, and disposal requirements established under
the law.
There are two principles regarding controlled substances that the pharmacy
technician should know: ordering and receiving schedule II controlled substances
requires special order forms and additional time (1-3 days), and these substances are
inventoried and tracked continuously. This type of inventory method is referred to as a
perpetual inventory process. Pharmacists and, in some institutions, pharmacy
technicians work with pharmacist to manage inventory, dispense, store, and control
narcotics and other controlled substances.

Expired Drugs
The most common reason drugs are returned to the manufacturer is because
they are expired. The process for returning drugs in the original manufacturer
packaging is straight forward and not particularly time consuming if done routinely.
Returning expired products to the manufacturer or wholesaler prevents the use of
these products, while enabling the department to receive either full or partial credit
for them. To return products, pharmacy personnel must complete the paperwork
required by the manufacturer/wholesaler and package the products so that it may be
shipped. Technicians often perform these duties under the supervision of a
pharmacist.
Some pharmacies contract with an outside vendor that completes the
paperwork and coordinates the return of these products for an agreed upon fee.
Pharmaceuticals compounded or repackaged by the pharmacy department cannot be
returned and must be disposed of after they have expired. It is important to dispose of
these products for safety reasons. Proper disposal prevents the use of sub-potent
products or products where sterility can no longer be guaranteed. The precise
procedure for disposal is dependent upon the type and content of the products.


17

CONCLUSION
The movement of pharmaceuticals into and out of the pharmacy requires an
organized, systematic, and cooperative approach. The pharmacy technician plays a
vital role in maintaining the functionality of these systems. Pharmacy technicians
familiarity with product conditions and uses puts them in a position to identify quality
and care issues that can strengthen the purchasing and inventory control system.
An effective purchasing and inventory control system requires all pharmacy
staff to understand and actively participate in the system, however, certain staff are
responsible for managing the pharmacy inventory and purchasing system. As the
primary handlers of medication in the pharmacy medication preparation system,
pharmacy techniciansperformance is critical to the success of the purchasing and
inventory control system.
The job of any manger in the business sector is to create an environment in
which the financial and human resources of the firm are used to generate profit. Even
in a small pharmacy, considerable financial resources are invested in the goods for
sale. With drug prices being as high as they are, several hundred thousand dollars are
tied up in the inventory, equipment, and fixtures of each pharmacy.
As a worker whose job handling your pharmacys inventory, you can help make
the best use of this investment. In addition, in hospital pharmacies and larger
community stores, some technicians specialize in purchasing; they spend the majority
of their time checking inventory levels, placing orders, and following up on items not
received.





















18














GLOSSARY OF TERMS

Cost of Goods Sold (COGS) The pharmacys acquisition cost - what is paid to buy the
product. For the purpose of this text, COGS is the replacement cost.
Cycle Stock Working inventory. The portion of inventory that creates a service level.
Cycle stock does not include safety stock or stock purchased as a result of
forward buying opportunities.
Days Inventory on Hand The number of selling days covered by inventory before an
out-of-stock occurs.
Economic Order Quantity The precise amount of a product needed to cover (EOQ)
demand without tying up cash in unnecessary inventory.
Formulary A list of drugs stocked in a hospital or managed care pharmacy, or a list of
drug products from which managed care physicians select an appropriate
medication for patient treatment. There are two types of formularies. In an open
formulary, all products are covered. In a closed formulary, only drugs on the
formulary are covered.
Forward Buying, Investment Buying Purchase of a larger quantity of a product than
required for current needs in anticipation of a price increase. Can also apply
when taking advantage of a special discount or free-goods offer.
Free Goods Products supplied without charge on an order for a specified amount of
merchandise. Free goods are usually obtained by sending the invoice to the
manufacturer.
Gross Margin Dollars, Gross Profit Dollars Amount of profit earned between the
pharmacys cost of goods and selling price before rebates, discounts, returns,
etc.
Gross Margin Percent Typically referred to as Gross Margin. Gross Margin is profit
expressed as a percent of sell.
Example: Item sells for: $ 1.00
Cost of Item . $ .80
19

Profit ($) .20
GM = Profit / Sell Price (.20 / 1.00), therefore, GM = 20%
Inventory Accounting Methods Different ways of valuing the pharmacys inventory as
it leaves the pharmacy for the customer. The three methods most commonly
used are FIFO (first in, first out), LIFO (last in, first out), and NIFO (next in, first
out). A description of how these methods affect inventory follows in the example
below.
Example:
Inventory Unit Cost
One $1
Two $1
Three $1
Four $1
Five $2
FIFO (first in, first out): The product on the shelf cost the pharmacy $1. A week
later the manufacturer had a price increase to $2. The pharmacy has four
units that it purchased at $1 and one unit that it purchased at $2. As the
product goes out the door to the customer, the pharmacy will charge $1 plus
mark-up until it reaches the inventory that cost $2. Then it will charge $2 plus
the mark-up.
LIFO (last in, first out): Using the same scenario as above, all parameters are
the same; except when the product goes out the door, the pharmacy charges
$2 plus the mark-up even if the product was acquired at $1. This means we
use the last acquisition price to the pharmacy for all units of inventory.
NIFO (next in, first out): Again, using the same scenario as in the above
example, all parameters are the same except the manufacturer has
announced a price increase to $3, to occur thirty days from now. When the
product goes out the door, the pharmacy charges $3 plus mark-up even
though it acquired the product at $1 and $2. This means the pharmacy uses
the next acquisition price (replacement cost) for all units including those
purchased for $1 and $2.
Inventory Turn A turn describes how often inventory moves out or turns over.
Inventory turns are calculated by: Cost of Goods Sold / Merchandise Inventory
= Turns. Merchandise inventory is inventory available for sale.
Item Ranking A system to rank items by demand either by dollars or by units.
Just-In-Time A method of inventory management where orders are placed so those
new goods arrive as the last units from the prior shipment move out.
Landed Cost The total cost of product after taking into account all discounts,
allowances, advertising dollars, promotional moneys, etc.
Lead Time A factor used in ordering, based upon the number of days from the time an
order is placed to the time its available in inventory.
Mark-Up Also known as cost-plus. Mark-up is the percentage added to the cost of a
product to determine its selling price. Mark-up is also profit, expressed as a
percentage of cost.
20

Example: Item sells for $1.00
Cost of item $ .80
Profit ($) .20
Mark-up = Profit / Cost (.20 / .80), therefore, Mark-up = 25%
Net Inventory Total merchandise inventory less accounts payable.
Order Point A level of product in unit and days on which buyers base
purchasing decisions. When on-hand and onorder are below the order point,
an order must be placed.
Example: Order Point = 100
On-hand = 50, On-order = 49,
Total = 99; order is placed.

On-hand = 50, On-order = 51,
Total = 101; order is not triggered until the sum of on-hand and
on order is at or below 100
Overstock Inventory on-hand in excess of the order point.
Owned Inventory The same as net inventory. The total merchandise inventory, less
the accounts payable suppliers.
Payment on Consignment Payment to the supplier due only after merchandise has
been sold.
Payment Terms The time limit for paying an invoice and the cash discount allowed,
e.g., 2% 30 days, net 31 days.
There are many different payment terms.
Some examples of terms used are:
Semi-monthly: The pharmacy pays one-half of its receivables on the first half of
the month and the remainder during the second half of the
month.
Invoices dated 1
th
15
th
Due: 25
th
Invoices dated 16
th
- EOM Due: 10
th
Weekly terms: Invoices for any given week are due on a defined day the
following week.
Price Protection The protection of existing inventory obtained from the manufacturer
against loss by price reduction. Typically given in the form of a rebate. This
should always be sought on new generic equivalent drugs.
Safety Stock Supply of an item kept on hand to compensate for variations in lead time
and item demand.
Standing Order An order containing the same products to be shipped each time during
the cycle. Shipped on the time frame established by the pharmacy: weekly,
biweekly, monthly, etc.
Stock Keeping Unit Each item is identified by a separate SKU. (SKU)



21


























References:
Crawford, S.Y. and Myers, C.E., ASHP National Survey of Hospital-Based
Pharmaceutical Services 1992, American Journal of Hospital Pharmacy
50(1993)L 1371-1404.
Declaration of Intent: Revision of Accreditation Standards in 1990s in Keeping with
Changes in Pharmacy Practice and Pharmaceutical Education. American Council
on Pharmaceutical Education, Sept. 1989.
Helper, C.D. and Strand, L.M., Opportunities and Responsibilities in Pharmaceutical
Care, American Journal of Hospital Pharmacy 47(1990): 533-543.
Hynniman, C.E., Drug Product Distribution Systems and Departmental Operations,
American Journal of Hospital Pharmacy 48, Supplement 1(1991): s24-35.
Joint Commission on Accreditation of Healthcare Organizations, Examples of Drug Use
Evaluation (Chicago, 1989): 1-83.
Lee, M.P. and Ray, M.D., Planning for Pharmaceutical Care, American Journal of
Hospital Pharmacy 50(1993): 1153-1158.
Practice Standards of the American Society of Hospital Pharmacist 1991-1992, p. 10. St.
Jean, A.D. and Landis N.T., The Pharmacoeconomist An Emerging Specialist in
Health Care Institutions, American Journal of Hospital Pharmacy 50(1993):
1062, 1066, 1068, 1073.
22

Weston, F.J. and Brigham, E.F., eds., Managerial Finance, Seventh Edition (Hinsdale,
Ill.: The Dryden Press, 1981): 302-336.


























FINAL EXAM

1. A pharmacys __________________ represents its single largest investment.
a. Equipment
b. Insurance
c. Inventory
d. Lunch budget

2. For every 1% change in an average pharmacys cost of goods sold, profits may
increase or decrease by slightly more than _____.
a. 1%
b. 20%
c. 10%
d. 15%

3. The objective of an inventory control system is to make inventory decisions that:
a. Minimize the total cost of inventory
b. Minimize inventory
c. Maximize inventory
23

d. Minimize labor cost

4. Which of the following is not a cost of carrying inventory:
a. Carrying cost
b. Shortage cost
c. Replenishment cost
d. Directive cost

5. A successfully implemented inventory control program takes into account such
things as:
a. Purchasing goods commensurate with demand
b. Seasonal variations
c. Changing usage patterns
d. Monitoring for pilferage
e. All of the above

6. Successful inventory management involves simultaneously attempting to balance
the _______ of inventory with the __________ of inventory.
a. Size, cost
b. Cost, benefits
c. Demand, cost
d. Benefits, demand

7. Despite the importance of inventory control in the overall management of a
pharmacys assets, there is not denying that this activity can be time-consuming
and expensive.
a. True
b. False

8. Irrespective of what the actual cost are of holding specific items in inventory, all
items should be managed the same.
a. True
b. False

9. In a typical pharmacy, approximately 20% of the most expensive inventory items
may account for ___ or more of the inventory investment.
a. 20%
b. 50%
c. 10%
d. 90%

10. _____________ is the interval between placing an order and having it ready for
dispensing.
a. ABC Classification System
b. Lead Time
c. Safety stock
d. Reorder point
24


11. _________________ is the extra units of inventory carried as protection against
possible stock-outs.
a. ABC Classification System
b. Lead Time
c. Safety Stock
d. Reorder Point

12. ___________________ is the inventory level at which it is appropriate to
replenish stock.
a. ABC Classification System
b. Lead Time
c. Safety Stock
d. Reorder Point

13. In general, a high turnover rate indicates that product usage is good relative to
the average amount of inventory kept in stock.
a. True
b. False

14. If a pharmacy purchases $200.000 per month and keeps an average of $500,000
on-hand, what is the inventory turnover rate for this pharmacy?
a. 9.2 inventory turns per year
b. 4.8 inventory turns per year
c. 8.4 inventory turns per year
d. 6.0 inventory turns per year

15. The Economic Order Quantity Model answers what question?
a. When should an item be reordered?
b. What costs are associated with an item?
c. What quantity should be ordered?
d. Both a and c


16. The EOQ is based on which of these assumptions?
a. The pharmacy does not know with certainty the annual usage of a particular
item of inventory (demand).
b. The rate of usage of inventory varies greatly over time.
c. Orders placed to replenish the inventory are received after the point in time
when inventory is zero.
d. None of the above.

17. Approving a vendors invoice for payment is an example of what type of cost?
a. Carrying costs
b. Shortage costs
c. Replenishment costs

25

18. Inventory shrinkage and obsolescence is an example of what type of cost?
a. Carrying costs
b. Shortage costs
c. Replenishment costs

19. The cost of putting away stock receipts and moving materials within the
pharmacy is an example of what type of cost?
a. Carrying costs
b. Shortage costs
c. Replenishment costs

20. The cost associated with not having sufficient stock to meet demand is known as
what type of cost?
a. Carrying costs
b. Shortage costs
c. Replenishment costs

21. Issuing a purchase order is an example of what type of costs?
a. Carrying costs
b. Shortage Costs
c. Replenishment costs

22. Which method of controlling inventory is the optimum method to be used alone?
a. Open-to-buy-budget method
b. Short-list method
c. Minimum and maximum method
d. Stock record card method

23. The inventory control method that is bested suited for settings where duplicate or
reserve stock is maintained and monitored by more rigorous methods?
a. Open-to-buy-budget method
b. Short-list method
c. Minimum and maximum method
d. Stock record card method



24. Which inventory control methods main objective is to determine when and how
much to order of each item?
a. Open-to-buy-budget method
b. Short-list method
c. Minimum and maximum method
d. Stock record card method

25. Which method of controlling inventory limits purchases to a specific amount of
funds available for purchasing pharmaceuticals during a specific period of time?
a. Open-to-buy-budget method
26

b. Short-list method
c. Minimum and maximum method
d. Stock record card method

26. Once purchasing policies are established in a pharmacy, they should be strictly
adhered to and never deviated from.
a. True
b. False

27. Which of the following is not a criteria for selecting a vendor?
a. Reliability
b. Price
c. Risk
d. All of the above
e. None of the above

28. Selecting and working with capable wholesalers is a significant function of
pharmacy purchasing.
a. True
b. False

29. It is a hard and fast rule that you should use only 1 wholesaler.
a. True
b. False

30. Purchasing policy in most pharmacies traditionally requires at least ___ supply
sources.
a. One
b. Two
c. Three
d. Four

31. Determining reorder points depends on:
a. Order lead time
b. Usage rates (demand)
c. Safety stock
d. All of the above



32. To establish effective safety stock policies, it is necessary to make a trade-off
between two opposing factors:
a. Capital cost and risk costs
b. Inventory service cost and storage space cost
c. The cost of carry safety stock and the cost of being out of stock
d. None of the above

27

33. Which of the following is not a factor in supplier negotiations?
a. Drug recalls
b. Quantity discounts
c. Promotional discounts
d. Return goods policies

34. ________ ____________ are reductions in price allowed for buying certain
quantities.
a. Promotional discounts
b. Trade discounts
c. Cash discounts
d. Quantity discounts

35. There are disadvantage to taking quantity discounts.
a. True
b. False

36. Which is not a classification of inventory control system?
a. Stock cards
b. Perpetual
c. Visual
d. Periodic

37. The least expensive and generally the least effective system of inventory control is:
a. Visual system
b. Periodic system
c. Perpetual system

38. The most elaborate and accurate basic inventory control system is:
a. Visual system
b. Periodic system
c. Perpetual system

39. The C items in a pharmacy are generally managed using which inventory
control system?
a. Visual system
b. Periodic system
c. Perpetual system

40. The most serious limitation of the _________ system is the measurement at a
single point in time.
a. Visual
b. Periodic
c. Perpetual

41. With the _______ system, the inventory is monitored at all times.
a. Visual
28

b. Periodic
c. Perpetual

42. Since most wholesalers use robotics and bar coding, it is no longer necessary to
check in your order.
a. True
b. False

43. Moving products with the soonest expiration date to the front of the bin or shelf is
referred to as:
a. The receiving process
b. The storing process
c. Stock rotation

44. Products of similar color, shape, and size which could result in errors are referred
to as:
a. Look-alike products
b. Misleading labeled product
c. Controlled substances
d. Expired drugs

45. What actions should be taken if the pharmacy receives a drug recall notice?
a. Check to see if the recalled products are in stock
b. Gather and package any recalled products
c. Write a summary of actions on the recall letter
d. File the recall letter
e. All of the above

46. Which inventory system should be used with controlled substances?
a. Visual
b. Periodic
c. Perpetual

47. The most common reason drugs are returned to the manufacturer is:
a. Order errors
b. Shipment errors
c. Expired drugs
d. Mislabeled

48. Pharmaceuticals compounded or repackaged by the pharmacy department can be
returned to the manufacturer or wholesaler.
a. True
b. False

49. A method of inventory management where orders are placed so those new goods
arrive as the last units from the prior shipment move out is referred to as:
a. Visual
29

b. Just In-Time
c. Perpetual
d. Periodic

50. Inventory on-hand in excess of the order point is referred to as:
a. Net inventory
b. Owned inventory
c. Overstock
d. Free goods