CEO Advisor Newsletter December 2018
Control Fixed and Variable Costs/Expenses to Increase Profits
Whether you are coping with a cash flow crisis - or just looking for ways to save on Costs and Expenses to improve your company's profitability - the service of a disciplined third party objective business advisor can be the catalyst you need.
Understanding the difference between Fixed and Variable is key. Let's look at these two types of Budget items in business - Fixed Expenses and Variable Costs.
Fixed Expenses are those that are not related to the amount of sales or production. They usually include rent, insurance, marketing, utilities or other expenses needed for running the business. Fixed Expenses can change over a period of time, although the increase or decrease is not directly connected to sales volume.
Variable Costs tend to be directly related to sales volume or business activity. Direct labor, raw materials and inventory are all Cost of Goods Sold and are perfect examples of the Variable Costs of a business. Service and production-related businesses require direct labor and outsourced contractors that directly service customers and this is a Variable Cost. You will ramp up direct labor personnel as your business grows, and you will bring in independent contractor labor as sales volumes spike temporarily.
So now, you must be wondering just how to lower these Costs and Expenses in order to control your spending and stay on Budget. Well, there isn't one cut and dry answer, and you will need to examine your whole business strategy to determine how to achieve Cost and Expense savings without impacting your business adversely. Paradoxically, sometimes in order to save money you will need to spend money, such as upgrading the technology or equipment in use.
Here are some effective Variable Cost and Fixed Expense saving strategies:
Scrutinize Your Products or Services. Make sure your Financials pinpoint your Cost of Goods Sold and Gross Profit Margin. Quantify which of your services are the most and the least profitable. Cut back or eliminate products and services that give you the least Gross Profits, while investing in those products and services that are the most lucrative. Create efficiencies to more profitably service your customers.
Make Variable Costs Your Target. Monitor and cut fluctuating costs like direct labor, independent contractors, shipping and materials first, before targeting Fixed Expenses like general and administrative salaries, rent and utilities. A reduction in your Gross Profit Margin is the best indication of the need to cut Cost of Goods Sold, such as direct labor, contractors, customer support, personnel, etc. Proper tracking and reporting will also greatly improve your ability to access information for improved decision making.
Question Every Fixed Cost in Your Business. Look at general and administrative expenses and salaries for savings, and evaluate marketing programs and ineffective salespeople to further reduce Expenses, while improving your operations and your Net Profits. Assess every Expense, including rent and see how each one adds to the value of your business. Does it make any difference to the bottom line? Are there any other options to healthcare coverage, administrative salaries, office supplies? Are there better, faster, cheaper ways of doing things?
Vendor Terms. Work out improved terms with your vendors. This effort will pay off many times over. The goal is to pay vendors in a comparable manner as your customers pay you.
Monitor Receivables. One of the fastest ways to get into a cash flow crisis is to provide goods or services to slow-paying customers. Slow paying customers create a need to tap your line of credit which in turn increases your Interest Expense. Being proactive about monitoring Receivables is essential to any business.
Here are other suggestions:Send invoices as soon as the product has been shipped or the service performed. Waiting until the end of the month just means you wait longer for payment.Offer incentives for customers to pay invoices quickly. Everyone loves better terms - and a small discount of 1% - 2% may well off-set the cost of collection efforts.If you accept credit card payments, shop around and make sure you're getting the best deal possible on payment processing. Seek out alternatives to credit cards such as ACH. These are hard decisions that can require additional professional help. CEO Advisor, Inc. provides CEO advisory services, including cost cutting and restructuring, sales planning and mergers and acquisitions advisory services and other services to CEOs and owners of small and midsize companies.
Using Your Budget
to Control Costs and Set Financial Goals
If you haven't completed your 2019 Budget, you should consider gaining help from a business advisor who is willing to take the time and provide the expertise to create financial goals for your business to maximize your Net Profit. 1. Costs vs ExpensesCosts are directly related to creating your products or servicing your customers, such as materials, direct labor, customer support, etc. Sales minus Costs equal your Gross Profit. Expenses, on the other hand, are general and administrative, sales and marketing related, such as executive salaries, rent, trade shows, sales salaries and commissions, etc. Properly tracking your Costs and Expenses against your 2019 Budget is critical to maximizing Net Profits. 2. Use a Line Item MethodWhen you created your chart of accounts in your accounting software, you created categories such as direct labor, office supplies, office rent and repairs and maintenance. For the purpose of Cost and Expense control, you want to create a 2019 Budget broken down into subcategories in order to track in detail. This will give you specific information on exactly where the money is being spent so you can monitor and correct any excesses. Comparing your actual Costs and Expenses to the Budget, and the actual amount spent a year earlier on the same items, is a good way to see if your Costs and Expenses are in line and in order to optimize your Net Profit. 3. Monitor on a Regular BasisEven when the trend is exactly where you want it to be, don't give up the regular habit of monitoring Costs and Expenses against Budget. This requires monthly accountability on your part and the part of your managers. Meet with your management team at the end of each month and quarter and reinforce the discipline needed to keep Costs and Expenses within Budget. 4. Give Budget Authority to ManagersA critical element in accountability and success is assigning responsibility for bottom line results. At the beginning of each month, identify the amount of money budgeted for each department and ask the department manager to create a list of priorities along with anticipated Costs and Expenditures. Then, at the end of each month, check the results of their expenditures against the amounts budgeted. Perhaps you can include an incentive program for those who come in under Budget or exceed Net Profit goals. 5. Use Purchase OrdersWhether in the corporate world or the world of small business, it is human nature to spend all the money in the Budget because there is always some marketing idea to squeeze in or some piece of equipment to upgrade or replace. Be disciplined and resist that urge. Require signed Purchase Orders, approved by the Accounting department, with any expenditure over a certain amount. Purchase Orders can be a critical aspect of holding your team accountable to the Budget, staying on Budget and meeting your Net Profit goals. 6. Planning, Budgeting and ForecastingTo grow your business profitably or avoid a cash flow crisis, you must be proactive and smart. Create a brief Business Plan to focus your time and your business strategy. Create a monthly Financial Forecast with goals and use it as a disciplined Budget to monitor and cut Costs and Expenses. 7. Be Prepared to SacrificeA healthy business can create a great return and reward you and your employees with tremendous growth opportunities. Don't make the mistake of choosing short-term satisfaction at the risk of long-term stability. Consult an expert business advisor to assist in the above critical steps - this can be the difference in making it through a crisis or achieving your Net Profit goals. Planning, forecasting, budgeting and cost controls require specialized expertise. CEO Advisor, Inc. can assist you in business planning, forecasting and keeping your monthly spending within Budget, while continuing to maintain growth and productivity.