How to Effectively Manage Business Costs

September 6th, 2011   •   no comments   

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There is an old management adage which says that “you cannot manage what you cannot measure”.

While this saying may be true in all parts of a company, it is especially critical when it comes to managing how money flows in and out of your firm.

Time and time again, you’ll read “shocking news” about seemingly thriving companies and businesses going under due to poor financial management.

Growth at All Costs is Costly!

By chasing after relentless growth – at all costs – these enterprises extend far beyond their abilities to pay spiraling bills to suppliers, employees, and financiers.

Beyond indiscriminate borrowing, the other “sins” of the leadership and boards of these firms are their failure to respond to the true financial pictures of their organisations. Often, these business leaders prefer not to dabble in the icky world of financial figures, preferring instead to spend their time on “sexy” things like business strategy, creative ideas, and future forecasting.

Unfortunately, money management is one thing that you cannot delegate too much. Every business leader, from managers of business units to the CEO himself, needs to get a grasp of the numbers.

What should you do as an entrepreneur or senior manager to manage your business costs better?

#1 Learn to Read Financial Statements

First, it is important for all managers to gain some degree of financial literacy.

Understand the difference between profit and loss, cashflow and balance sheet statements. Work out your key financial ratios such as your profitability, current ratio, debt-to-equity ratio, and Return On Investments (ROI).

This should apply not only to senior managers but line managers.

#2 Monitor and Report Business Costs – Not Just Sales

Second, incorporate reporting processes that mandate not only a reporting of sales and profits but the costs of achieving them.

These costs shouldn’t just be the cost of goods sold but should include operating expenses and overheads like utilities, office/shop rentals, salaries, and so on.

A good way of measuring the wider costs incurred in each transaction can be found in Activity-Based Costing (ABC), which is defined by Wikipedia as follows:

Activity-based costing (ABC) is a special costing model that identifies activities in an organization and assigns the cost of each activity with resources to all products and services according to the actual consumption by each. This model assigns more indirect costs (overhead) into direct costs compared to conventional costing models.

#3 Use Software and Systems to Keep Track

Third, invest in business software and systems that helps you to capture costs at various stages.

These can range from off-the-shelf small business offerings from Peachtree or MYOB to more complex applications from Oracle and SAP. The important thing is to have a system that can generate a regular cost profile for you as frequently as you need it.

#4 Share Common Functions to Achieve Scale Economies

Fourth, aggregate functions and processes within your organisation to reduce inefficiencies as much as possible.

These could be as simple as bulk purchases, sharing of administrative staff, to using common IT systems and platforms. Beyond this, you may also wish to lease rather than buy spaces, equipment, and other assets.

#5 Ensure Team Members are Cost Sensitive

Fifth, ensure that team members are sensitive to the total costs of each transaction.

Other than direct costs that goes to suppliers and service providers, indirect costs like time, opportunity costs, and others should also be considered.

Reward staff not only for achieving sales or performance targets, but for doing so with the least amount of costs.

#6 Adopt Productive Habits

Sixth, adopt productive business practices wherever possible.

There are a whole range of tools out there depending on your individual circumstances.  They include measuring one’s Cost Of Quality (COQ), reducing shopfloor waste through the application of the 7 Wastes/ and 5S, applying Business Process Reengineering (BPR), Economic Value Added (EVA), and more.

#7 Streamline Your Supply and Delivery Chain

Seventh, examine your entire business process and how the costs can be managed for every link in the chain.

These can cover a wide span of activities – from sourcing of raw materials, manufacturing, logistics, packaging, delivery, sales, customer service, to all administrative and office costs.

See if you can finetune the system such that costs can be optimised along the entire stretch.

#8 Fine Tune Your Sales Forecasts

Finally, improve your sales forecasting methods as much as possible.  Now this is probably the hardest to achieve, but some semblance of a pro forma model can be derived by looking at historical records, competitors, and industry averages.

The more accurately you can predict your future revenues (through using predictive models on Excel Spreadsheets for example), the better your business will run.

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