Cost Management
In a bad economy, and even in normal times, cost management and, as importantly, cost awareness is key to a business’ success. It is easy when you are in the thick of your day to day operations – serving customers, managing employees, cleaning your store and similar – to forget to spend the time to review your costs.
If you are not preparing a financial income statement every month, you should be doing so. This is probably the most important part of cost management. A typical income statement will start out with revenue, your sales for the month on the top line, but below that will be listed all the expenses you incur. These expenses should be reviewed carefully each month and compared to previous month numbers as well.
To start, do a line by line analysis and make sure you know where every dollar is going. If you have not heard of a vendor, ask who they are and what they do. Tthis can also help prevent against fraudulent activity. If a particular item looks too high or too low, find out why. Review the invoice, compare it to a previous invoice and understand the issue.
A great example heard recently was a business owner that did not review his utility bills for some time. When he did he realized his electric costs were astronomical. The reason, as it turned out, was that some receiving personnel where propping open the door to a food storage freezer as they received in new products for as much as an hour at a time. This lost energy was the reason for his high bills and because he was not watching those bills or comparing them to previous month, it cost him a lot of money.
This article is too short too focus on every possible expense but the key elements of an analysis are as follows:
1. Understand the driver for the cost. For example payroll expense is typically driven by the number of hours each employee works and their hourly rate and of course by the number of employees you have.
2. Understand how and why the expense you are reviewing fluctuates in your business. For example, payroll will generally fluctuate based on the hours you are open and staffed, your staffing levels, and the rates of pay you give your staff.
3. Finally understand what you can do to manage the expense on a daily, weekly and/or monthly basis. Continuing our example, payroll can be managed by limiting the store to fewer hours open, fewer staff on site at any one time, and lower pay rates-perhaps offset by higher commission rates.
4. Then develop a plan to watch and manage the line item on a regular basis.
As you progress, you will realize that some costs are easily managed and need little attention on a month to month basis. For example rent expense rarely changes more than once a year. Other line items deserve weekly if not daily attention, for example hourly payroll costs. As you identify the expenses you can manage the most, develop a simple report that allows you to track the expense over the period you have chosen. You will be amazed how the simple act of putting that report together will make you think about those expenses in a new and analytic way and having the report will keep them front and center for your attention on a regular basis.
Of course, financial considerations are only the start of this kind of analysis and the next steps need to consider the indirect impacts your cost management efforts can have. This is also where the effort becomes more of an art than a science. For example if you have fewer staff, will you harm customer service? If you pay less, will you have a lower quality individual for your staff? However you cannot even get to those latter important questions if you do not understand the underlying cost elements as well.
Someone once said, “Manage your costs, don’t let them manage you” a lesson we can all learn from.
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