How To Master Inventory Management Of DME

By David Edward Marcinko, MBA, CFP, CMP

Supply chain inventory management (SCIM) is essential for doctors who perform a number of similar procedures, those who dispense a fair number of products and surgeons because a medical practice’s profitability will suffer if it has too much or too little inventory of durable medical equipment (DME) on hand. How can a physician determine the proper DME inventory level? One uncommonly used approach is based on the economic order quantity costing (EOQC) method. EOQC is a century-old accounting formula that determines the point at which the combination of order costs and inventory carrying costs is the least expensive and inventory most profitable. This is the goal of SCIM. There are three key assumptions with the EOQC model: revenues (inventory depletion) are constant, costs per order are stable and just-in-time delivery allows the placement of orders so new orders arrive when inventory approaches zero. How does the physician determine current inventory costs and proceed to implement a SCIM policy such as EOQC? The approach involves the following steps: • perform an inventory of all DME in the office, clinic or ASC; • analyze how much DME inventory is on-hand; • determine associated inventory and ordering costs; and • perform an EOQC analysis. Why are procedurally based practices still not taking advantage of these basic DME inventory processes? Part of the answer is economies of scale as most podiatry practices are still small businesses incapable of large-scale SCIM initiatives. This will change in the near future as the pace of industry mergers, consolidation and acquisitions increases, and multiple offices and clinics form larger enterprise business units that require more DME and improved fiscal control of inventory. Another problem is inaccurate input data. Accurate product costs, activity costs, forecasts, history and lead times are crucial in developing DME inventory models that work. Understanding The EOQC Calculation The mathematical formula for EOQC is the square root of two multiplied by SO/C, in which S is the annual usage or purchases in units, O is the cost per order and C is the annual carrying cost per unit. S = Annual usage or purchase in units. Typically, annual purchases in units and cost per order are based on historic estimates. However, better forecasting and reduced lead times to operate with reduced inventory stock can also decrease inventory levels and annual use. O = Cost per order. Order cost is the sum of the fixed costs that are incurred each time one orders a DME item. These costs are not associated with the quantity ordered, but the physical activities required to process the order. This would include the costs to enter the purchase order and/or requisition, any approval steps, the cost to process the receipt, incoming inspection, invoice processing and vendor payment. In some cases, a portion of the inbound freight may also be included in order costs. The time spent checking in the receipt, entering the receipt and doing any other related paperwork would also be included in order costs, while the time spent repacking materials, unloading boxes or trucks and delivering items to satellite offices would not. Inbound quality inspection — in which a percentage of the quantity received is examined — would include the time to get the specifications and process the paperwork, but not include the actual time spent inspecting the DME items. One must also include the time associated with creating the purchase order, approval steps, contacting the vendor, expediting and reviewing order reports. All time spent dealing with vendor invoices would be included in order costs. Also be aware that e-procurement, vendor-managed inventories, bar coding, radio frequency identification devices (RFIDs) and vendor certification programs can also reduce costs per order. C = Annual carrying cost per unit. Also called holding costs, carrying cost is the annual cost per average on-hand inventory unit. There are several primary components of carrying costs that may represent a source of lost profits. These include rent, utilities, insurance, taxes, employee costs and the interest rate and opportunity costs of having office space or capital tied up in DME. For the purpose of the EOQC calculation, if the cost does not change because of the quantity of inventory on hand, it should not be included in carrying costs.

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