Reducing Costs - A Six-Step Framework for Small and Mid-Sized Businesses
Our previous article addressed raising prices. In this article, we look at how small and mid-sized businesses can reduce costs. Cutting costs is challenging. You grew your company and made decisions to get to where you are and you must re-think some of those decisions to adapt and thrive. You have to make decisions that will affect, sometimes negatively, your employees, your vendors, and your customers. The purpose of this article is to give you a starting point and framework to follow so you can focus on your decisions rather than figuring out how to proceed.
Step 1: Identify Your Goals
Start with the goal in mind. Prepare a forecast that realistically projects revenue and cash flow for the foreseeable future. A simple cash flow forecast starts with your profit and loss forecast and then adjusts for non-cash expenses. For example, subtract depreciation and amortization, which are non-cash expenses. Include capital expenditures, and other cash outlays that you may record on your balance sheet—e.g, development costs that you capitalize, fixed asset purchases, inventory accumulation, etc
Step 2: Review 12-month Trailing Trends
Review your expenses by month for the last 12-month period. This review should start with a simple by-month profit and loss report. Review operating expenses, including general and administrative, marketing, interest, travel, rent, etc.
Highlight outliers and drill into these outliers to understand the nature of the expenses. Pay the most attention to the high costs. For those expense line items you don’t understand, drill into those as well. You may need to run payroll and benefits reports for the labor expense line items.
Step 3: Categorize
The next step is to categorize the significant items:
Lights On - expenses you must pay to keep the lights on or continue functioning such as, utilities, internet, certain types of software, taxes, etc.
Payroll and Wages - includes benefits and this typically require the most work to reach a decision
Marketing - balance reduced marketing spending vs. the impact on revenue
Rent - office, warehouse, etc. - review your leases and consider expansion plans
Meals, Entertainment, Team Building, Education, Dues, and Subscriptions - various costs to consider on a case by case basis
Office supplies, etc. - may be partially discretionary but not always significant enough to have an impact.
Having the costs in proper categories will help you to review costs at a higher level rather than focusing on individual expenses that may not have a significant impact.
Step 4: Make Decisions
You now know how much you need to reduce and the levers you can pull. Deciding to cut back on areas you have helped to grow is difficult but necessary.
Generally, payroll reductions have the most impact on cost savings. They also have the most disruption to your business. It’s essential to be prepared for the disruption and communicate early and often why the reductions are necessary. You may need to estimate severance pay for personnel who are part of the reduction.
If your marketing efforts have a known ROI, you can use the impact on revenue to guide your decision. For those without an ROI, the decision may be more complicated.
Rent may appear inflexible because of your lease agreement, but you may be able to negotiate a sub-lease option or similarly favorable terms.
Financing costs are often overlooked but worth reviewing for potential savings. For example, you may have taken on expensive debt during your growth phase when financing costs were not your top priority. Now that your company is larger, you may be able to find more favorable terms.
The remaining costs may require detailed review and better controls of spending on incidental expenses. If you don’t have an approval process or a budget vs. actual spending review, now is the time to implement these management tools.
Step 5: Communicate and Execute
It is critical to communicate with your team and get them on board to help execute the changes. Emphasize that this is a necessary step that will result in a better company. The article, How to cut costs — and get your employees to help suggests the following approach:
Communicate early and often — Engage employees through a clear communication plan
Solicit input — It’s essential to get input for company reduction targets, lest they appear arbitrary.
Move quickly — Delays breed uncertainty, so it is vital to establish a detailed timetable and stick to it.
Step 6: Track Progress
Compare your budgeted vs. actual costs each month. Take note and learn from the expected cost reductions that didn’t pan out. For example, you may have reduced the number of trade shows you attended but have increased other marketing expenditures to keep your sales on target. Revisit your plan each quarter and make adjustments accordingly.
How We Can Help
Highpoint CFO provides CFO consulting services. Contact us to find out how we can help you with forecasting, cash flow and working capital management, by-product profitability reporting, and data analysis using business intelligence tools such as Power BI.
About Highpoint CFO
Highpoint CFO is a CFO consulting firm based in Tampa, Florida that serves clients throughout the US.
Scott Young is the President and Principal Consultant at Highpoint CFO. He is a CPA, Certified Merger & Acquisition Advisor (CM&AA), and Certified Value Growth Advisor (CVGA) with over 25 years of experience in finance and accounting at industry-leading companies.
#smallbusiness #mediumbusiness #consulting #CFO
Sources and Recommended Reading:
Jon Katzenbach (2008). How to cut costs — and get your employees to help Strategy&. Digital Article.
Kevin Coyne, Shawn T. Coyne, and Edward J. Coyne, Sr. (May 2010) When You’ve Got to Cut Costs—Now Harvard Business Review. Magazine Article.
