Businesses are already taking casualties from the current financial crisis. Companies are freezing hiring, laying off employees, and cutting costs. Though a complete collapse of the financial system has been avoided, many small businesses are still feeling the pressure from the current economic crisis. It has become clear that a quick recovery is not on the books. Customers are more nervous about their own income and spending. As this circle continues, it will continue to pressure small businesses to make the most of their resources and make some tough choices if they’re going to survive the current crisis.
If a business is having a hard time generating revenues during these times then it becomes critical that a full scale Cost Analysis be done in order to preserve cash. To do this, you will need a thorough understanding of the following types of costs: 1) Fixed Cost, 2) Variable Cost, 3) Direct Cost, and 4) Indirect Cost.
Understanding the way cost behave is the first step in the process of controlling these costs. I’ll have more to say about the various costs categories in future e-Letters. For now, let’s put aside the theory for a moment and discuss some concrete examples that I have implemented over the years that have led to a reduction in costs while still maintaining a high level of service. The key in this analysis is trying to understand what triggers a cost. If you can determine this, then you can start to: a) control it, and b) reduce it.
Example 1: Postage expense
At a company that I worked for, we had large volumes of invoices that we generated on a monthly basis. Therefore, our monthly postage expense was significant. What triggered this cost? Well, the more invoices you mailed out, the greater the cost. Thus, in a way, it’s like a variable cost only it does not fluctuate with sales like true variable costs.
Here’s what I did. I contacted our major customers and asked if we could email the invoices to them instead of mailing them. They agreed, as long as it was in an acceptable format. This cut our cost by 70 percent and it improved our cash flow since the client received our invoices faster.
Example 2: Cell phone expense
Two things trigger cell phone cost: 1) the number of cell phones, and 2) the type of plan. Regardless of the number of cell phones you currently have in use, you should always have a thorough understanding of the plan your company signed up for and the usage by your employees. At one company, I was surprised to see that the plan that was in place was overly generous. Most employees never hit the allowable monthly minutes and this cost the company a lot of money. Also, perform the occasional audit of cell phone usage. This will tell you if employees are using the phone solely for business and it tells employees that you are watching them. It goes without saying that the more cell phones you have the greater the cost. It’s a variable cost with respect to the number of employees that need them.
Example 3: Salary expense
This cost is triggered by two things: 1) the number of employees, and 2) the need. Obviously, the more staff you have on payroll the greater the cost. When employees are hired, it’s because there is a need
within the organization. A manager requires an additional headcount to fill a job position. If you look at
this “need” as the trigger point and focus your analysis on this, you may be able to reduce your cost significantly. This will require an analysis of: 1) all the major functions that are being done within the organization and 2) who is responsible for these functions. At one company I worked for, we downsized from 80 employees to 60 and we still managed to get the work done.
Example 4: Rent expense:
Rent is considered a fixed cost. The question then becomes, does rent expense have a trigger point? Well, rent is a fixed monthly cost based on the square footage that you are occupying. Thus, the more area you rent the greater the cost. Now that you know that the trigger point is the square footage being rented, can this be modified? In two companies I worked for we subleased the area that was no longer needed to support our business. Some companies have this capability, while others do not.
I have many more examples that I can share with the group, but I’ll stop at this point. The main purpose of this e-Letter is to stress the fact that if you want to cut or control your costs you MUST understand what triggers these costs. This may appear too simplistic of a solution. The reality is if you focus on the basics you should get good results. I suggest that you take your most current Income Statement and look at each expense and try to identify what triggers each expense item. Once you determine that, then you can start on identifying ways to control or cut these costs.
Anthony is an investment advisor with RBC Dominion Securities who specializes in dealing with individuals who own or operate small businesses. Anthony has over 20 years experience in providing advice to these individuals and the monthly e-Letter he issues has been a positive resource for many companies.
Anthony Pichelli, CMA – Investment Advisor – RBC Dominion Securities
Office: 416-733-5255 Cell: 416-315-3183 email:anthony.pichelli@rbc.com
