From the smallest proprietorship to the largest international conglomerate, arbitrarily cutting costs can be a “quick fix” for improving the bottom line in a challenging economic climate. However, some cost management techniques may not be in the best long-term interest of an otherwise thriving company.
Many business owners respond to unexpected pressures by reducing costs without a definitive plan of action; their course is reactive instead of proactive. However, this type of action may be shortsighted unless in accordance with the company’s business plan. While cutting payroll costs, for example, may at first appear to alleviate an immediate problem, sometimes only the symptoms, rather than the root of the problem, have been addressed. Regardless of the size of your business, effective cost management is needed to build a solid foundation for the future.
The focus of a plan with more vision would entail managing costs rather than simply cutting costs. Managing costs is a proactive process of consciously choosing to spend in areas with the potential to produce a positive financial return. On the other hand, cutting costs is a reactive process, which typically happens when a situation seems to be escalating “out of control.”
While both courses of action strive to eliminate waste, effective cost management relates costs to profits, whereas cost cutting is not necessarily related to profits. A haphazard approach could result in an illusion of a better bottom line, when in fact productivity and profitability may be slipping.
Building Blocks for an Action Plan
Define the relationship between costs and revenues. What are your sources of income? Some businesses are product-based, while others are service-oriented. Your business might depend on a combination of both. Understanding your revenue structure will create an awareness of the costs entailed in generating the revenue stream. Which costs are directly related to producing revenue, and which are general overhead?
Reduce inter-departmental complexity. In any company or organization, the operations of one department affect the others. Is the work being accomplished efficiently or are there unnecessary steps in the process? Are there redundant practices? Do people communicate effectively?
Encourage employee involvement. Most employees develop an expertise as time goes on in what they do because they do it every day. Establish a rapport with personnel by seeking their advice and tapping into their creativity. Ask your employees for input before making decisions. By soliciting their suggestions for specific cost problems, you may not only gain a new perspective, but in the process, motivate your workforce to become part of the solution.
Measure decisions against your business strategy. Effective cost management decisions must be measured against your long-term business strategy, rather than within the confines of a short-term plan. For example, if one of your suppliers has reduced prices to get rid of excess inventory, what are you accomplishing if you buy more than you need for your customers? How will your cash flow be affected? Will you be stuck with excess inventory if the market changes unexpectedly?
In a competitive and unpredictable marketplace, effective cost management is an important component of any successful business. By being aware of your expenses and how they impact the bottom line, you will be in a far better position to create a solid foundation for your business so it can thrive over the long term.