Article By:
Frank Sirianni
| | | FINANCE Watch the Warning Signs | | Friday, 29 September 2006 |
Whether investing in new pharmacy or managing your existing pharmacy, there are a number of warning signs which signal the importance of getting the right balance of equity and debt in your pharmacy financial structure.
Attracted by the likely boost to wealth by further acquisitions or larger pharmacies or the tax benefits, many pharmacists have been tempted to borrow significant sums from banks willing to lend to pharmacy.
Pharmacy owners should use finance to support their strategy with a clear understanding of future cash flows and investment requirements. The analysis should also take account of the alternative market environments in which pharmacy could operate in the future as well as the business plan you may have.
While I am personally optimistic about the 'survival' of pharmacy and the resilience of many pharmacy owners, each of us needs to realistically assess the possible impact of alternative scenarios on our business(es).
A systematic approach is required which removes the emotion from the process, tests the impact of alternatives, and better aligns finance with your personal and business strategy.
table 1: Warning Signs
| Sign | Further details | | Banks tighten lending | Banks, for the first time in 10 or more years, are tightening their lending policies. Aggressive Banks who sought to gather market share are now rejecting deals! | | Margin pressure | Margin pressures are being driven across a number of fronts:
- PBS reduction in margins unlikely to be offset by the wholesalers
- Generic pricing being monitored and likely to be further clawed back by Government
- Retail competition from non-pharmacy retailers aggressively marketing health & beauty
- Big Box pharmacy warehouses increasing in number and further competing on price
| | Volume declines | Current evidence suggests the PBS is in decline or achieving only moderate growth. Current estimates are that growth for the 2005/06 financial year are 42.5% of the growth for 2004/05 with the PBS growth being 34.5%. Respectively a decline in growth rates by 58.5% and 66.7% That's a significant slow down! |
The warning signs have been with us before. However, in many ways, they have been irrelevant to or ignored by the market. The reasons are multi-dimensional and may be the subject of another article.
The key focus of this article is that anecdotal evidence suggests that bankers are becoming increasingly concerned about ill prepared business owners (finance applicants) seeking high levels of borrowing and are reacting by tightening policies. The banks are also expressing concern about the prices being paid for poorly performing pharmacies.
This is being reflected in closer scrutiny of applications, higher information required in applications, and, in some cases, higher 'risk margins' being charged to loans.
Review financial performance in the light of warning signals
A very successful pharmacist often reminds me that "anyone can make money when sales are growing and expenses are relatively moderate. The test of a good business operator, is to see how they perform when competition is high and there is limited or no growth."
table 2: Example tests of your pharmacy
| Test for | Explain | | Decrease in margins by 2% | Margins will inevitably decline in pharmacy. It has been a fact throughout the history of pharmacy and is a fundamental economic law of retailing. Coupled with Governments' need to manage health budgets, your plan needs to be tested for significant further decreases in margins.
Medici Capital estimates that the current rate of decline in margins is approximately 1% compound per annum. | | Sales decline of 5% | Current evidence suggests a significant decline in both PBS volume and overall value. Historically, pharmacy retail growth has been marginal in both real and nominal terms. Hence, retail is unlikely to offset the decline in PBS.
A 5% decline is very likely for many pharmacies. A good plan will test for the impact of this scenario while planning how to achieve growth. | | Wages increase by 10% | Staff shortages, both dispensary and retail, have been with us for some time. To date, a wages blow-out has not been obvious. However, with further growth in business size and pharmacies under management, a significant increase in wages is possible. | | Rent increases by 5% | While such increases are common in major shopping centres and with commercial landlords, they need to be tested in a low sales growth environment. Historically, increases at higher that CPI levels have been funded through sales growth. Given the likelihood of limited growth for many pharmacies (except the exceptional operators), the "assumption of capacity to pay" needs to be tested for your pharmacy. |
Table 2 displays some of the tests you or your business adviser should complete when assessing:
- the affordability of the proposed borrowing;
- your ability to survive in possible market down turns (regardless of how probable you believe these to be); and
- your business plans and strategy.
Frank Sirianni can be contacted at Medici Capital, PO Box 80 KEW VIC 3101. Medici Capital, industry leaders in pharmacy valuation, finance & management consulting. Helping pharmacists achieve their goals. www.medici.com.au |
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