It is shocking to see that the average small business has to increase sales and revenue with as much as 22% every year, just to cover annual increasing cost! No wonder, most business don't make it to year 5.
In this article, I will focus on how to reduce Fixed and Variable cost first, because it is very important to make sure you are profitable before you start to increase sales. This is also the fastest and easiest way to increase profits because you can implement it immediately, although it may take a few weeks to see the results, Expenses have an ugly habit of accumulating over time and eliminate all your hard-earned profits.
“Expenses will always rise to meet income”
Step 1: Set A Target
Before you start with the first step in reducing your cost, first set a target for how much profit you want, then discover with how much you need to improve each profit driver. All you have to do then is focus on what you need to do each and every day to get to your target, and you will have what you want.
Step 2: Reduce Your Fixed Cost
Now, I’m sure you know exactly how to do this, but for everybody’s sake, I will explain some of the most effective ways.
Whatever the size of your business, I can tell you this, you can always cut costs. Out of experience, I know that any business can reduce costs by 10%. So don't forget to be tough on costs to save your business or to increase profits.
Analyze and evaluate each and every expense on an individual basis. Start by identifying and dividing all your costs as either Fixed or Variable cost. Your fixed costs will always remain constant. They do not vary with your sales volume. These are the costs of keeping your doors open, whether any product is sold or produced or service is delivered.
Make sure you get the most out of it and that you are paying the minimum for that expense without jeopardizing your business. Keep an open eye and open mind, be very creative, and you will be surprised at what you can accomplish.
Fixed costs include: Rent, utilities insurance, salaries, phone bills, legal and accounting fees, marketing, advertising, auto, travel, Internet connection, office supplies, repairs and maintenance, postage and all costs not directly related to the actual production of products or delivery of services.
And don’t forget about that small amounts that you sometimes take out of the business and forget about it, like snacks, coffee, lotto tickets, you get the picture. These small amounts can add up to a decent amount.
To reduce your cost with 10 % is actually very easy. If you take 10 different expenses and only save 1% on each of them, you have accomplished your goal. Remember, small changes in all areas = big difference. Use the tool in the previous video to help you evaluate each and every expense on an individual basis
But 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. Remember, The goal is to reduce business expenses without sacrificing quality or lead to negative consequences
Take wages for instance, in difficult times people will often think of dismissing team members. This may be an appropriate cause of action, but it needs to be considered carefully. Sometimes it's better to invest in team members training improving productivity, client service and sales
If you look at marketing in general, 50% of the money you're spent on advertising is wasted because you are probably not testing and measuring the results of your advertising. By improving your advertising, you can save money on ineffective marketing and increase sales by improving their results. More about this in another article
I have included a little bonus for you, an Excel spreadsheet to help you with calculating your costs. You can find it in the "Cost Reduction Tool" on our free tools page.
Fixed cost calculator
Convert as many of your fixed expenses into Variable cost by Outsourcing non-core activities or non-profit business units, and pay only for results.
Step 3: Reduce Your Variable Cost
This is known as COGS (Cost Of Goods Sold) also known as COGM (Cost Of Goods Manufactured) or COS (Cost Of Sales)
It is very important to know your Variable cost because this is normally your biggest expense. In general, if you are like the majority of businesses out there, this cost will make up plus minus 70% of your total expenses. A small saving or improvement of only 1% in this area can have a huge increase of up to 75% in net profit
First, understand that the idea behind COGS (Cost Of Goods Sold) is to measure (all costs which are variable) directly associated with making or buying the product or delivering the service. Only businesses that buy, carry and sell inventory need to calculate COGS. A manufacturing business need to calculate COGM (Cost Of Goods Manufactured) In some cases a manufacturing business need to calculate COGM and COGS for the finished products. And lastly, a Service business need to calculate COS (Cost Of Sales)
They are all Variable Costs, because the cost varies with the number of units you sell or produce. Double your sales and COGS will double. Sell zero and COGS will be zero. This is the cost to produce or purchase your product (raw materials, inventory, direct labor, packaging, commissions, freight) or to perform your service (hourly rate, commission, travel to client, entertainment, various service-related costs).
COGS include: The actual stuff you sell, like the burger and the bun. Plus packaging & shipping costs, plate and napkin, ketchup and mustard, and relevant labor. Sales commissions are another common expense that should be included in COGS, If sales commission is paid when you generate revenue through a sale of your product or service. Utilities might be up for debate because your utilities might go up or down based heavily upon your sales volume, Phone bills will in general be a fixed cost unless you use it for telesales, and it goes up or down based upon your sales volume
Analyze and evaluate each and every expense on an individual basis and strive to improve 1% on each of them. It will also be a great thing to get your employees involved in brainstorming ways to reduce cost and increase productivity.
How To Calculate Your Variable Cost
COGS (Cost Of Goods Sold) for Retail and Wholesalers (Non-manufacturing)
You can start with your available inventory at the beginning of the month + the cost of goods purchased during the month and other related variable cost = cost of goods available for the month – ending inventory at the end of the month = cost of goods sold for the month. When you calculate COGS, you start with:
1. Your inventory value at the beginning of the month,
2. Add purchases during the month,
3. Add the cost of labor, packaging, cost of freight, and other related variable cost for the month
4. Subtract the inventory value remaining at the end of the month.
Use the Excel spreadsheet tool to help you with calculating your COGS. You can find it in the "Cost Reduction Tool" on our free tools page.
COGM (Cost Of Goods Manufactured) for Producers (Manufacturing)
You can start with
1. Calculate your cost of goods manufactured for the month,
2. Add the value of your opening goods inventory and
3. Subtract the value of your closing goods inventory.
Use the Excel spreadsheet tool to help you with calculating your COGM. You can find it in the "Cost Reduction Tool" on our free tools page.
COS (Cost Of Sales) for service businesses
So what if you operate a service business, or develop and sell software, what is your COGS?
Because you may not have any opening and closing inventory, you only have to calculate your variable cost for the month. This can include direct cost that you have to get the job done like: fuel, direct labor, sales commission and so on. Remember, the idea behind COS (Cost Of Sales) is to measure all costs which are variable and directly associated with delivering your service.
How To Reduce Your Variable Cost
There are hundreds of strategies for cutting COGS, depending on your industry, and I’m not going to go into detail about them because it will take several videos, but you can search on Google for strategies in your related industry.
In difficult times - It is crucial to get control of your cash. You have to centralize the control of cash receipts and payments, before you go any further, make sure you tell “everyone” that you are taking personal control of cash flow. Control purchasing and expenditure – orders above a certain amount must be approved, and it must be established whether they are necessary. Don't buy anything that is not absolutely required. Profits will soon flow from very tight cash flow management.
Step 3: It's Time For Step By Step Action
Now that you know your numbers, you are set for success. All you have to do now is focus on them on a daily, weekly and monthly basis; Make sure you reach your targets for every key success factor, and you will be guaranteed to make your profit goals.
Use the "Profit Mini Sniper Tool" (Image below). You can find it on our free tools page. Put these numbers into our Profit tool and have fun, play around with your numbers, change a percentage or two in your business key success drivers and see how you can create some extraordinary results
Take action as soon as possible and improve your cost-cutting action as you go along. This is the most important step and the one where many owners fall down. Fear, resistance, life getting in the way—those are just a few of the reasons we offer, for failing to take action on a plan. Success requires that you just do it.
Again, it's very critical to measure your results. How are you going to know if your actions are working? Measuring your results allows you to make informed, accurate decisions based on what’s really happening in your business. Did your profit strategy work? Why or why not? Make improvements, test out your new strategy, and use what you learn to refine your strategy for further growth.
The process of taking action, measuring, revising and measuring again will go on as long as you’re interested in improving the profitability of your business.
Until next time, and thanks for reading the article.