The Med Spa Fallacy (Part 2 of a 2 Part Series)

A few weeks ago, I posted Part 1 of this 2 Part Series addressing the MedSpa Fallacy …. That MedSpa is HealthCare.? In Part 1, we discussed that MedSpa may look like HealthCare, but it acts like Retail.? Many of the processes and procedures used in the MedSpa environment should mirror processes used by retailers.? In that initial article, we addressed revenue and revenue recognition and why MedSpa is different than traditional HealthCare.? However, when speaking with MedSpa owners, more often than not, I get asked about Inventory and COGS as they present interesting challenges for a typical MedSpa.? In Part 2 of my MedSpa Fallacy article, I would like to talk about Inventory and Cost of Goods Sold (COGS) and these issues that present challenges for MedSpa businesses.

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Inventory, especially neurotoxins, dermal fillers, and retail skin care products, have a high cost leading to high Inventory and high COGS in all three categories.? Fillers and retail skin care products are often promoted by the manufacturers, causing frequent cost fluctuations for the same product.? Retail product, mostly sold through the front desk, varies by MedSpa in terms of the depth and breadth of assortment.? Most MedSpas have not invested in inventory management systems making it difficult to track purchases, receipts, and inventory movement.? Many do not track product receipts, making it difficult to know if you are paying for inventory that was not receipted.? Even if the MedSpa is disciplined about entering usage into their electronic medical records (EMR) system, the COGS generated by the EMR is typically inaccurate because of the impact of shrink in most practices.?

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So with all of these inventory and COGS challenges, what are the best ways to track and account for COGS and inventory?

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In MedSpa, there are several different product categories:? neurotoxins, dermal fillers, esthetician supplies, general supplies, retail product, just to name some of the more relevant.? I would argue that purchases for some of these categories should be inventoried and purchases for others should book directly to COGS.? I would recommend that MedSpas inventory, at a minimum, neurotoxins, dermal fillers, and retail products and perhaps consider taking most other categories directly to COGS as purchased.? For example, neurotoxins are typically purchased in certain sized vials.? The vials are easy to count, it is easy to track usage of the product, and they have a high cost.? Similarly, dermal fillers are typically sold by the box and each box contains one or two injection syringes.? Again, they are easy to count, easy to track usage of, and another high cost item.? Other products, for example general supplies, are a little more difficult to count and track.? Items such a needles, syringes, gloves, etc. are low in cost and typical packages are higher quantity.? This is a category where a MedSpa may choose to take product directly to COGS as it is purchased.? Since these products are lower in cost, are time-consuming to count, and hard to track usage on a per client basis it makes more sense to expense them as they are purchased.?

Under generally accepted accounting principles, inventory should be valued at the lower of cost or market value.? Since neurotoxins, dermal fillers, and many retail products turn relatively quickly, market value may not be an issue.? Understanding your inventory cost, however, may be a little trickier due to “free” products that are offered to MedSpas by suppliers.

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In the MedSpa world, free products typically come in two forms.? First, purchasing incentives often come in the form of free product (ie:? buy 10 boxes of filler, get 2 boxes free).? In the case of such promotional product, it is important that free products be received and counted into live inventory and used to buy down the unit cost of the product.? For example, if a MedSpa purchased 10 boxes of product for $2400, the unit cost of each box would be $240.? Using this same example, if on the same order, the supplier added 2 additional boxes of product for free, the unit cost per box is now reduced to $200 per box ($2400 total order divided by 12 boxes).? What complicates the inventory value, and ultimately the unit cost used as COGS, is that a free offer may be valid today, but not tomorrow, so the price paid for the same product may differ from day to day.? Therefore, it is important to have an inventory management system that can calculate a weighted average unit cost in order to value inventory and record COGS at the correct cost.? Unfortunately, most EMR systems do not have this capability, so investing in a procurement to pay solution that offers inventory management may be a better way to go.

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The second type of free product is what I will refer to as “trunk stock”.? Trunk stock reflects samples or other products that a supplier representative may offer for free when visiting a MedSpa location.? At times, these products are packaged as “sample items” and not intended for sale.? Other times, the pack size may be smaller but the packaging may be identical to ordered items.? Trunk stock items are often offered to MedSpa teams for use in educating and training their providers on the application and efficacy of the product.? However, suppliers do not always require this product be used for training.? When possible, the MedSpa is smart to bring this product into live inventory and use it to buy down their unit cost.? However, it is prudent to understand whether using this product for client service impedes supplier contract terms or violates state or local laws.? I always recommend reaching out to legal counsel for advice on the use of trunk stock.

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Now that we understand a little more about accounting for MedSpa inventory, let us now explore the best methods of recording COGS.? We have already identified product categories where purchases should book directly to COGS.? It is the inventoried categories where the challenges come into play.?

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There are several approaches that can be used to book COGS.? First, if the MedSpa has procedures for tracking usage of inventoried categories and it tracks that usage on a per client basis, then the EMR can be used to track the usage and to record the COGS.? The trick is to ensure that the EMR is regularly updated to reflect the correct weighted average unit cost of the product.? If a weighted average unit cost is not available, the MedSpa could also choose to use a standard cost approach where a cost is established for each inventoried item and used consistently for booking COGS.? Under either of these methods, a MedSpa will still need to periodically perform a physical count of on-hand inventory to capture the shrink inherent in the business.?

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Another method that can be used to book COGS is to record purchases plus or minus the change in inventory.? Under this method, it is imperative that a frequent inventory count is taken for each inventoried item, typically weekly or monthly, and that the count is sampled and verified by an individual not participating in the count.? This method may be more time intensive, but is the better method for capturing shrink on a more real time basis.

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And let’s talk quickly about shrink.? There are 2 types of shrink, known and unknown.? Examples of known shrink include losses on neurotoxins that are experienced in the reconstitution process, product that has to be discarded because it is beyond expiration date, or product that is lost due to breakage or spillage.? Known shrink should be tracked and submitted to the accounting teams for proper recording and monitoring.?

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Unknown shrink mostly reflects theft or loss.? Most often, this type of shrink goes unobserved and is only discovered during a physical inventory count process.? Understanding drivers behind this type of shrink and how to prevent it are key in reducing the overall cost associated with shrink.

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Clearly, there is much that needs to be thought about and much that needs to be considered when developing inventory and COGS procedures in a MedSpa environment.? However, solid inventory procedures and controls can make or break the profitability of the best of MedSpas.? Determining the right systems, processes, and controls should be a primary focus for each business.?