Financial data analyzing. Counting on calculator. Close-up. Selective focus
You may have heard the phrase, "You can't cut your way to profitability;" a true statement relative to business growth and acquisition, though managing and controlling cost is an often overlooked strategic tool which can add considerable profit to the bottom line.
Consider for a moment a company with annual revenue of $200,000, purchases of $120,000, and a profit of $16,000 before tax. By achieving just a 5 per cent reduction in purchase spending, profits would increase by 38 per cent, or $6,000. Achieving a $6,000 increase in profit through increased sales, assuming similar purchases, might well require an increase of $76,000 in sales, or 38 per cent. Considering the time and effort expended to increase sales, these numbers make cost reduction a powerful tool to increase profitability.
For many small and mid-sized organizations, achieving a 5 per cent reduction in operating costs is quite achievable, mainly as a result of primary efforts and resources having been invested in increasing sales, and not in managing or reducing cost.
Here are five strategies which can be employed to reduce cost and improve profits over the long-term:
1. Develop a spend strategy. Creating a simple, forward-looking document will help to identify spend patterns and plans, allowing for intelligent decisions related to investment of working capital. This technique is similar to developing sales forecasts; however, when spend strategies are combined with sales forecasts, the results are a more holistic view of business health. Many business owners naturally believe in times of increasing sales that profits are healthy and additional spending will have little impact on the bottom line, only to emerge from growth periods with profits which are less than expected. If not managed appropriately, increasing sales can result in increased cost, and when compounded by poor investment decisions profits are directly impacted.
2. Just one is never enough. Obtaining multiple quotes is a time consuming exercise, and can often seem wasteful and unnecessary. But setting a spend threshold over which multiple quotes will be obtained provides a means of managing time and ensuring best price on investments. If you were taking a trip to Montreal, you likely would book accommodations with little thought to cost. If you were taking a trip to the Bahamas, more than likely you would search out several offers to ensure you are receiving the best overall value. The same methodology should be applied to your business.
3. Consolidate and leverage. Compiling larger volumes of spend with fewer suppliers applies to any size of business. Several of our clients have been amazed at the cost reductions achieved by simply pulling together multiple but similar spend categories, and sourcing to fewer suppliers. Service levels typically improve, and increased spending provides leverage to achieve other profitable opportunities such as discounted payment terms.
4. Manage relationships. With today's volatile economic climate, discussions with your financial advisor are likely frequent and in some cases may be heated. You wouldn't trust your advisor outright with managing your investment funds without providing some input on your financial goals, so why would you simply turn over business to a supplier without periodically checking the competitiveness of pricing and service levels? Strong relationships are built on trust, and without proof it is hard to build trust.
5. Monitor progress. To ensure progress is being made in managing costs, you must track progress. The simple use of a bar chart with targeted savings goals and a view of your current position is an effective visual management tool that can track progression and keep employees engaged. Similar to tracking fund-raising events, having the ability to see progress is a means of realizing whether inputs and efforts are delivering the expected results. If they aren't, it is time to change the approach, the process or both.
It may seem that investing time into managing cost is not justifiable, particularly when increasing sales is the key to business sustainability and growth. Consider, however, the impact of our earlier example; by simply maintaining existing sales and spend levels, a simple reduction in cost of 5 per cent will increase profits by 38 per cent. If that doesn't make good business sense, I am not sure what does.
Special to The Globe and Mail
Shawn Casemore has been helping clients increase profitability and improve operational efficiency for nearly two decades. To learn more visit www.casemoreandco.com or follow him on Twitter.
Join The Globe's Small Business LinkedIn group to network with other entrepreneurs and to discuss topical issues: http://linkd.in/jWWdzT