“Should you cut cost, or focus on increasing sales?” How do you choose, and which will work best for your unique business? Making the wrong decision can lead to lost time, money, or even business failure.
There is a large debate regarding this matter between "financial specialists" and marketing experts" for decades. The financial specialists recommend cutting cost and the marketing experts recommend focusing on sales. Everyone with his/her own opinion, believes, conviction and facts. "This has lead to a lot of wrong advice that have caused many small businesses to fail".
There’s only one absolute truth. You have to do a cost vs revenue analysis because no business is the same. In this article we will visually illustrate, compare and prove what effects both choices have on your business, so you can choose for your self.
From countless research results, Marketing, Sales and Money is the small business owner greatest challenge and concern. All growing small business has one thing in common: They always need a lot more money than they’ve got, and the faster the growth, the bigger the gap.
“Profit is the future cost of staying in business”
- Hans, The Business Sniper -
The first reality, is that if you're not profitable enough and your business is running on low-profit margins or experiencing cash flow problems, and you focus on sales, it will drain your last remaining cash flow, and you can fail, because the increased sales will eat up all your cash flow.
Increasing sales is widely seen as the key to increase profitability but this is a misconception. Time and again, sales figures, if increased in isolation, have failed to deliver increased profits.
Although "Sales" have the biggest potential for future growth and profits, it'd only one of a number of factors making up the profit formula. You need to understand how all the factors work together to make informed decisions to improve your profitability, growth and cash flow
The second reality, is if you strongly focus on cutting cost it may lead to poor quality, and bad service, or it may lead to even more reduced sales and profit, and with the business already under pressure it can also cause you to fail.
You Need To Fix Profit First
It is shocking to know that increasing cost is responsible for many small business failures and the main reason they don't make it to year 5. The average business have to increase sales with at least 22% just to cover their increased annual cost and to make the same profit as the previous year. And nobody is talking about this!
“Profit is an objective, NOT a reward”
- Hans, The Business Sniper -
For the average business that's making less than 3% net profit per annum (income after salary and before tax) and have a cost increase of only 2%, would need to increase sales with 22% just to make the same profit as the previous year? You need to cut cost and expenses. Expenses have an ugly habit of accumulating over time.
But cutting costs can be very tricky. You want to save money and increase profitability, but at the same time, you don’t want to cut costs that are actually helping you to increase sales. You need to do it in such a way that it doesn't affect your sales and revenue. The safest way to reduce cost and expenses without too much disruption or risk in your business. Is to reduce all expenses and cost with a small percentage.
Let's say for instance you have 15 different kinds of expenses, if you only reduce each of them with one percent it equals a 15% reduction. This is so small that it shouldn't have any big impact on your business but will have a huge impact on your overall profit.
You can do this by analyzing each and every expense on an individual basis. Make sure you get the most out of it. Cost reduction is not simply attempting to cut any and all expenses randomly you need to understand how these expenses relate to your sales, production, customer service and other parts of your business. Sometimes you can achieve greater profit through the more efficient use of these expenses.
For Every Business It Will Be Different.
But you can’t thrive and prosper…your business can’t explode with profits. You can’t capitalize on any big business opportunities out there. And you definitely can’t create tremendous prosperity for yourself — until and unless you first of all, maximize what you’re currently doing.
And you can’t maximize what you’re currently doing, if you don’t break your business down to its core success drivers. Because only when you do that can you measure, can you increase, can you improve and maximize the level of output and performance.
To increase, and improve the business level of output and performance, you must first understand what makes your businesses work. This process begins with an understanding of what drives your business and how you can affect those drivers in order to achieve your goals.
“Expenses will always rise to meet income”
- Brian Tracy -
To help you with analyzing your business and coming up with the best solution for your business we have made available several Free Tools including the one that we used in the images below.
Cost Reduction V/S. Sales Increase:
The Best Solution
The best strategy is to focus simultaneously on all 4 factors that drive profit and growth for any business. You can’t focus on only one or two. You have to focus on making small improvements in an all 4 factors.
Each of these 4 areas have their own success drivers, but more on that later.
These 4 drivers are:
- Increase your Sales every month.
- Reduce Variable costs (COGS)
- Increase your Markup % or the Price you charge.
- Reduce your Fixed costs
In order to maximize profit in any business, you have to increase your sales volume, decrease your fixed and variable costs and increase your price.
Cost Reduction V/S. Sales Increase:
Let's take this business for example that is doing 112 000 p/m in Sales. The Variable Cost for these sales was 89 700 p/m with a Markup % of 24.9 % on products. The monthly Fixed Cost for running the business was 19 500 p/m, making a Net Profit of 2 800 p/m (2.5% of Total Sales)
First, let see what happens if we focus only on Increasing Sales.
We had to Increase Sales by 10% to realize a Profit increase of 80% -
Now let see what happens if we Reduce All Cost.
We only had to Reduce Cost with 2% to realize the same Profit increase of 80% -
Now let see what happens if we Increase Prices.
We only had to Increase Prices with 2,5% to realize the same Profit increase of 80% -
Now let see what happens if we Improve All 4 Factors
We only had to Improve All 4 Factors with 1% to realize the same Profit increase of 80%
JUST FOR FUN lets see what happens if we make the same improvements as before.
Can you see why it is important to focus on all 4 factors? Anybody can make a 1% improvement in a very short time without risk of losing sales.
The real secret is to know your numbers, to measure, evaluate and to monitor them before making assumptions or business decisions that can have a huge impact on your business.
Remember to use the Free Tools that we made available to help you.
Thanks for reading the post
Important: Now, I'm not recommending you simply dive in and start changing things. Action without a plan in business is never a good idea and you may end up taking some serious risks. Before you start selecting and implementing strategies to improve your profit, you need to determine what your current numbers and situation are.