If you want to improve the profit performance of your business, break even point analysis suggests that there are three main ways:
- To increase sales volumes
- To increase contribution rates
- To reduce fixed costs
Actions taken by turnaround consultants and business recovery experts suggest that in many cases, the fastest acting of these initiatives is to reduce fixed costs.
What Are Fixed Costs?
First a reminder of definitions.
Fixed costs are fixed in relation to volume over a normal level of business.
These costs will include items like property rent and many salaries.
These costs are not fixed over time but you normally have to make a deliberate decision to make cutbacks.
For more information about the distinction between fixed costs and the other type, variable costs, please read this article.
>>> The Cost Volume Profit Relationship
Fixed costs have a nasty habit of gradually increasing during times when the business is doing well. You know you can afford to buy a few luxuries or to take a few risky with expenses that may be help your business but might not.
>>> The Dangers Of Fixed Cost Creep
Making The Decision To Reduce Fixed Costs
Sometimes the decisions will be tough.
If you decide to reduce salaries, you will need to:
- Reduce the number of people who are employed (either by making someone redundant, dismissing them or not filling a vacancy when an employee leaves).
- Replace people who leave by recruiting at a lower level of experience.
- Negotiate a reduction in pay levels. This is what some businesses have done in the recession to avoid redundancies.
To reduce rent, it is likely that you will have to wait until there is a break clause in the lease or the lease finally expires.
- Negotiate a lower rent. Landlords are becoming more flexible because they earn nothing if the property is empty for a period.
- Give back some of the space you rent or, if allowed, sub-lease it to another tenant who will pay rent.
- Move to a different property where there is less space or where the price per square metre is lower.
Other times, the cost is much easier to control. You just decide to stop buying.
A technique I like very much is zero based thinking.
>>> Zero Based Thinking Clarifies Difficult Decisions
Look down the list of your costs – and it’s better to to with individual transactions than account analysis totals – and ask yourself the zero based question.
“Knowing what I know now, would I still buy this?”
If your answer is No, stop it as soon as you can.
If your answer is a firm Yes, you know that you’re committed to that cost.
Many will be in the middle and you can take some time to think about each.
Some business turnaround experts believe it is better to cut hard, get the costs right down and then build them back up if you cut too far.
What Causes Cost And How Do You Cut It At Source?
In general, you’ve got three factors to look at with every significant fixed cost:
- the quantity you buy
- the price you pay for the quantity
- the amount that is wasted and not used as well as it can be. If you can make better use of what you buy, the quantity you need will reduce.
If you’re not fully using a resource, and you want to get better value for money, you have some choices:
- to reduce the quantity you buy (this might mean a full time employee reduce their working hours to part time).
- to find other valuable uses for the resource (perhaps the employee can be given work responsibilities that take up your time and you can do more to increase sales revenue and contribution)
- to sell the spare capacity to a third party (this might mean, for example, offering your book-keeper’s services to your wife for her business as well as yours).
If you want guidance on prioritising the cost reviews, look for quick wins along two dimensions:
- High value
- Easy and quick to stop
The first to focus on are the big costs that can be stopped quickly and with little difficulty. The last are the small costs which are difficult to stop.
Try to base your decisions on what your business needs now and in its foreseeable future. While X% across the board savings can appear to be fair on the basis that “we’re all in this together”, reducing some costs will damage your business.
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