Cost of Ownership: How Much Pharmacy Can You Afford?
By John Pross |
Alternatively, you may already be a pharmacy owner looking to expand your business.
In either case, having capital and a core understanding of pharmacy financing will set you up for success once you’ve decided to pursue or extend ownership.
Let’s explore what you should know before purchasing a pharmacy.
Understanding what's out thereRight now, there’s a steady stream of pharmacy ownership opportunities hitting the market, but whether any of these pharmacies for sale are right for you depends on your price range, geographic preference and goals for customization. Maybe your dream pharmacy is one that’s struggling and has a price tag low enough you could afford to buy it with cash—a fixer-upper ripe for renovation and a host of new patient care services. Or maybe you would prefer to pay a million-dollar premium for a turnkey pharmacy that’s already firing on all cylinders. Both of these opportunities exist, so knowing what your preferences are will help you narrow down how much capital you’re going to need.
Likewise, knowing whether you’re aiming to stay in your own community or make a fresh start somewhere else will have a big impact on not only your search radius, but also your budget. The cost differential between urban, suburban and rural pharmacies can be staggering. It’s ideal if you can pinpoint locations where you’d be comfortable living during the next phase of your career—a timeframe that could realistically stretch over a decade or more.
Crunching the numbersLet’s say you’ve considered all these things and you decide you want to spend somewhere around $500,000. This includes the cost of the pharmacy, goodwill, inventory and working capital. Typically, the purchase would be arranged through a bank loan, which requires a down payment of 5 to 10 percent. In our hypothetical, you’d need $25,000 to $50,000 upfront for the down payment, with the balance to be paid off monthly with interest, typically over a 10-year period. To use round numbers, monthly payments would be about $5,000 over the course of the loan.
But that’s not the end of the story. Banks use a formula called debt service coverage ratio (DSCR) to ensure business operations will generate enough cash flow to cover loan payments. DSCR differs according to industry, but for an independent pharmacy loan, net operating income would need to exceed debt service by a factor of at least 1.5. So, for a loan totaling $60,000 annually, DSCR dictates that the pharmacy must generate at least $90,000 per year in profit.
And the bank won’t be looking at one year’s performance in isolation. While some pharmacies generate consistent cash flow year after year, others fluctuate over an extended period. Expect the bank to average anywhere from three to five years of cash flow to arrive at what it considers a reliable indicator. The bank will also account for rising or falling script counts and whether profit margin is improving or declining over the timeframe being evaluated.
Keeping the business runningDue diligence doesn’t stop with satisfying loan requirements when buying a pharmacy. As with any business, you should have a handle on how money flows in and out of the store to ensure you have enough capital on hand in case you need to make up for any shortages.
As a starting point, find out how much revenue comes in from third-party insurance companies to cover prescription reimbursement. That will range from 75 to 85 percent of total pharmacy revenue in most cases. Naturally, you’ll want to assess whether third-party income is being managed and collected with maximum efficiency.
When it comes to monetary outflows, the primary expense of running a pharmacy is cost of goods sold—how much inventory you would need to purchase week to week. According to the National Community Pharmacists Association (NCPA), cost of goods sold at independent pharmacies ranged between 76 and 78 percent of gross sales between 2008 and 2017.1
The next largest expense of running an independent pharmacy is payroll, which varied from 13 to 14.5 percent of gross sales during the 10-year period measured by NCPA.2 This figure includes your own projected salary, staff wages, health insurance, life insurance, disability, 401K plans and payroll taxes.
Other expenses at the top of the list are rent, utilities and marketing, which can be wild cards that depend on location and the size of your pharmacy. These may be relatively minor expenses for rural stores and ones that are under 1,000 square feet, but they could potentially be huge monthly outlays in metro areas, such as New York City, and for pharmacies larger than your average mansion.
Planning for the unexpectedHistorically, pharmacies have seen their share of financially impactful changes over the years. As such, it’s good practice to build in a safety net to help you navigate unforeseen expenses.
For instance, an insurer may do a billing audit and determine that prescription reimbursement should be withheld due to an actual or perceived problem. If that happened, you’d still have to order inventory in the interim until the audit was resolved, which could leave you tens of thousands of dollars in the hole. Having emergency funds set aside would help you get through tough situations like that when there are disruptions to your cash flow.
Ideally, the pharmacy you purchase will consistently bring in enough revenue to cover all your expenses every month with plenty left over to build up a reliable rainy-day fund, but that doesn’t always happen overnight. This is the reason why you can’t figure out how to finance a pharmacy based on down payment and monthly loan payments alone. You need to consider all the ancillary costs as well, both with and without current cash flow. When you plan accordingly for all the expenses associated with owning an independent pharmacy, finding the one that’s right for you will no longer be a shot in the dark; it’ll be a calculated move that sets you up for less stress and more success.
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