Many businesses use cost control strategies to minimize expenses and increase profits. But, the short-sighted and reckless cutting of costs won’t necessarily benefit a company and often has a negative impact on the business.
Cost management is a more strategic way of proactively eliminating waste in the business and increasing efficiency. If you are just using a bookkeeper to enter figures, you might not notice runaway costs until you have a serious cash flow issue.
Since a proactive approach is always best, here are seven steps to more effective cost management.
1. Define Your Fixed and Variable Expenses
Before you do anything else, print out a list of all of your transactions for a given period (month or quarter). Then, put either “fixed” or “variable” next to each one.
Not sure which to choose? A fixed expense is one that doesn’t change each month, such as your rent or insurance. A variable cost fluctuates, such as hourly labor, electricity, and raw materials.
2. Make Use of Your Business Budget
You should have a business budget and most likely use some type of accounting software, but do the two interact? If not, they should.
In this next step, enter your business budget into your software so that you can see how your current fixed and variable expenses stack up to what you planned. Specifically, you can run a budget-to-actual report that has variances.
3. Create a Cost Management Strategy
Now that you have this valuable data, it’s time to create a cost management strategy that considers your particular situation. Decide what you will focus on first. Will it be the highest dollar expenses, the ones with the largest variance from the budget, or the ones that fluctuate the most each month?
4. Reduce Variable Costs
Regardless of what strategy you choose, you’ll probably have some different types of expenses on your target list. Some strategies to reduce variable costs include:
Pursue volume discounts. If you can purchase in larger quantities, you may be able to secure better deals from some vendors. Even if it’s not advertised, be sure to ask.
Regularly review vendor contracts. Review your vendor contracts at least annually so that you can decide whether to renew them or look around for better terms with someone else.
Centralize purchasing. Try to have one person in the company that handles purchasing and vendor contract negotiations.
5. Reduce Fixed Expenses
Becoming complacent about fixed costs is common because there is the perception that you can’t do anything about them. This isn’t necessarily true. Review these opportunities to reduce fixed expenses:
Outsource if possible. If the cost of benefits and employment taxes are hurting your business, consider a few areas that you might be able to outsource.
Downsize where possible. Are you wasting space or not running efficiently? See if there are areas in which you can downsize and not jeopardize your business.
Look for new vendors. Similar to variable expenses, frequently review your contracts with vendors for fixed expenses. See if you can negotiate a better deal with the current vendor a new one.
Change how you pay staff. If you are considering layoffs to save money, see if you can change your compensation structure as an alternative. Some employees might be willing to accept lower base pay in exchange for higher incentivized pay.
6. Adjust Your Break-Even Point
Your company should have a designated figure that is its break-even point, or the revenue necessary to produce a profit of zero. The formula for this is:
Break-even Point = (Overhead costs + Balance Sheet Expenses)/Gross Margin
Once you put some of your cost management strategies in place, you’ll be able to adjust that break-even point. In other words, you make it lower and become profitable sooner.
7. Run Your Transaction Report Weekly
Managing costs isn’t a one and done exercise. It’s not something you should decide to do only when you have a cash flow issue. This is a practice that should be done often, with a recommendation of repeating it weekly. This way you can address problems and take advantage of opportunities before it’s too late.
Costs can begin to subtly creep up if you aren’t monitoring them and being fiscally responsible. When it comes to the financial future of your business, you want to get it right the first time. While these strategies are effective, you might need some outside help to put them in place or assist with other short and long-term financial objectives.
Capital Business Strategies helps small business clients throughout the Warren area with accounting, payroll, tax, and planning services. Contact us now to learn more about how we can help your business with cost management and other business-related needs.