subject: How Can I Cut My Business Operating Expenses? [print this page] Increasing profits through cost reduction must be based on the concept of an organized, planned Expense Management program. Cost reduction is not simply attempting to slash any and all expenses unmethodically. The Director or Manager must understand the nature of expenses and how expenses inter-relate with revenues, inventories, cost of goods sold, gross profits, and net profits.
Cost reduction does not mean only the reduction of specific expenses. You can achieve greater profits through more efficient use of the expense dollar. Some of the ways you do this are by increasing the average sale per customer.
Before you can determine whether cutting expenses will increase profits, you need information about your operation. This information can be obtained only if you have an adequate recordkeeping system. Such records will provide the figures to prepare a profit and loss statement (preferably monthly for most businesses), a budget, break-even calculations, and evaluations of your operating ratios compared with those of similar types of business.
Profit is in danger when good merchandising and cost control do not go hand in hand. A big revenues volume does not necessarily mean a big profit, as one national retailer learned.
Paying The Right Price
Your goal should be to pay the right price for prosperity. Determining that price for your operation goes beyond knowing what your expenses are. Reducing expenses to increase profit requires you to obtain the most efficient use of the expense dollar.
An understanding of the worth of each expense item comes from experience and an analysis of records. Adequate records tell what has happened. Their analysis provide facts which can help you set realistic goals, you are paying the right price for your companies prosperity.
Analyze Your Expenses
Sometimes you cannot cut an increase item or service price. But you can get more from it and thus increase your profits. In analyzing your expenses, you should use percentages rather than actual dollar amounts. For example, if you increase revenues and keep the dollar amount of an expense the same, you have decreased that expense as a percentage of revenues. When you decrease your cost percentage, you increase your percentage of profit.
On the other hand, if your revenue volume remains the same, you can increase the percentage of profit by reducing a specific item of expense. Your goal, of course, is to do both: to decrease specific expenses and increase their productive worth at the same time.
Before you can determine whether cutting expenses will increase profits, you need information about your operation. This information can be obtained only if you have an adequate recordkeeping system. Such records will provide the figures to prepare a profit and loss statement (preferably monthly for most businesses), a budget, break-even calculations, and evaluations of your operating ratios compared with those of similar types of business.
Break-even
A useful method for making expense comparisons is break-even analysis. Break-even is the point at which gross profit equals expenses. In a business year, it is the time at which your revenues volume has become sufficient to enable your over-all operation to start showing a profit.
Once your revenues volume reached the break-even point, your fixed expenses are covered. Beyond the break-even point, every dollar of revenues should earn you an equivalent additional profit percentage.
It is important to remember that once revenues pass the break-even point, the fixed expenses percentage goes down as the revenue volume goes up. Also the operating profit percentage increases at the same rate as the percentage rate for fixed expenses decreases - provided, of course, that variable expenses are kept in line.
Locating Reducible Expenses
Your profit and loss (or income) statement provides a summary of expense information and is the focal point in locating expenses that can be cut.
Regardless of the frequency, for the most information two P&L statements should be prepared. One statement should report revenues, expenses, profits and/or loss of your operations cumulatively for the current business year to date. The other should report on the same items for the last complete month or quarter. Each of the statements should also carry the following information:
1.this year's figures and each item as a percentage of revenues.
2.last year's figures and the percentages.
3.the difference between last year and this year - over or under.
4.budgeted figures and the respective percentages.
5.the difference between this year and the budgeted figures - over and under.
6.average percentages for your line of business (industry operating ratio) when available, and
7.the difference between your annual percentages and the industry ratios - under or over.
This information allows you to locate expense variation in three ways: (1) by comparing this year to last year, (2) by comparing expenses to your own budgeted figures, and (3) by comparing your percentages to the operating ratios for your line of business. The important basis for comparison is the percentage figure. It represents a common denominator for all three methods. When you have indicated the percentage variations, you should then study the dollar amounts to determine what line of operative action is needed.
Because your cost cutting will come largely from variable expenses, you should make sure that they are flagged on your P&L statements. Variable expenses are those which fluctuate with the increase or decrease of revenues volume. Some of them are: advertising, delivery, wrapping supplies, revenues salaries, commissions, and payroll taxes. Fixed expenses are those which stay the same regardless of revenues volume. Among them are: your salary, salaries for permanent non-selling employees (for example, the bookkeeper), depreciation, rent, and utilities.
A useful method for making expense comparisons is break-even analysis. Break-even is the point at which gross profit equals expenses. In a business year, it is the time at which your revenues volume has become sufficient to enable your over-all operation to start showing a profit. Once your revenues volume reached the break-even point, your fixed expenses are covered. Beyond the break-even point, every dollar of revenues should earn you an equivalent additional profit percentage.
It is important to remember that once revenues pass the break-even point, the fixed expenses percentage goes down as the revenues volume goes up. Also the operating profit percentage increases at the same rate as the percentage rate for fixed expenses decreases - provided, of course, that variable expenses are kept in line.
Sometimes you cannot cut an increase item. But you can get more from it and thus increase your profits. In analyzing your expenses, you should use percentages rather than actual dollar amounts. For example, if you increase revenues and keep the dollar amount of an expense the same, you have decreased that expense as a percentage of revenues. When you decrease your cost percentage, you increase your percentage of profit.
On the other hand, if your revenues volume remains the same, you can increase the percentage of profit by reducing a specific item of expense. Your goal, of course, is to do both: to decrease specific expenses and increase their productive worth at the same time.
by: Tom Mann
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