Making More Money From Your Business - Part 3

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Making More Money From Your Business - 3 of 3 - Fixed Costs

 

The breakeven point of a business is when the contribution margin from sales matches fixed costs.  Profit happens as a result of contribution margin from sales after breakeven has been achieved.  As discussed in the previous two installments of this series, in simple terms, you can improve contribution margin by raising prices or reducing variable costs, or both.  Finding the best combination of contribution margin and volume will optimize your profits.

Once you have squared away pricing and variable costs, there is the matter of fixed costs.  Fixed costs are the costs that happen whether you make a sale or not, such as rent.  They are the financial hole your business finds itself in at the beginning of every month out of which you dig yourself by applying contribution margin from sales until you breakeven, at which point contribution margin from sales becomes profit. 

Obviously reducing the depth of the fixed cost hole at the beginning of the month by reducing fixed costs so that profit happens sooner is desirable.  However, before you break out the financial axe, consider something:  fixed costs are also the investment in your business that allows you to produce profit.  Cut too much in the wrong areas, and you can reduce your profits by cutting fixed costs.  There can be opportunity costs created by cutting fixed costs.

Opportunity costs never appear on an income statement, as such.  However the effects of opportunity costs will manifest themselves in your bottom line.  As an example, suppose you are a sales organization and business is good.  Your sales people can barely keep up due to the administrative and processing activities that are a part of their job.  If they had support staff help, the better sales people could produce sales that generated 3x in additional contribution margin compared to the additional salary and benefits expense of the extra staff help.  You're trying to keep overhead low, so you tell your sales staff that they will have to do without the support staff.  Have you done yourself any favors?  Will you be more profitable because you kept the fixed costs of your operation low by not hiring support staff?

There isn't enough information in the scenario to answer with certainty.  The volume of business the support staff was hired to handle would have to be sustainable and the extra sales productivity that was the predicate of the decision to hire the additional support staff would have to be monitored and verified.   However, the additional support staff should at least be considered based on your understanding of current business conditions and ability to manage the extra productivity required for the additional support staff to make sense.  Other options might also be available like hiring temp staff so that if business slowed, the support headcount could be reduced without having to deal with the issues related to the hiring and firing of permanent staff.  In any event, sometimes adding fixed costs can increase profitability.

This holds true with any kind of investment in the business, such as marketing and additional production capacity.  The decision has to be based on whether the expense would increase profitability based on the additional contribution margin generated by added sales.  The converse is also true.  If you're cutting costs, make sure that the effect of the cuts doesn't reduce contribution margins in an amount greater than the fixed cost cuts.

So monitor your expenses and ask yourself this simple question:  Does this expense contribute to the core functioning of the business?  If it doesn't, why is it there?  All businesses have waste or legacy expenses that had value at one time but don't anymore.  Which are yours?  All businesses have opportunities to gain efficiencies.  Where are yours?

Here are eight thought starters you might consider to cut your fixed expenses and increase financial flexibility.

  1. Lease additional plant and equipment to service additional sales until you are absolutely sure the additional business is sustainable.  This will allow you to keep your cash reserves to invest in your business and give you an out if business slows.  It's easier to terminate a lease and turn in equipment than to sell a building or used equipment.
  2. Hire temporary workers to handle additional sales until you are absolutely certain the additional business is sustainable.  It's a lot easier to eliminate temporary workers than to terminate full time employees.
  3. Renegotiate your lease.  As I'm writing this blog, the country is in an economic slowdown.  There are commercial vacancies everywhere.  It's a buyer's market.  Take a look at what kind of a facilities deal might be available in the marketplace.  Use that as leverage to get your current landlord to reduce your rent.
  4. Take a look at your service contracts.  Is the cost worth the benefit?
  5. Require management or senior management approval for all overtime worked.  Examine why overtime was necessary and take steps to fix the problem.
  6. Review the transportation costs, express costs and courier costs you pay for.  Is there a less expensive way to achieve the same result?  Is the same result even necessary or could a lower cost option with less performance be adequate?
  7. Use cooperative advertising to reduce your marketing expenses.  With co-op advertising, your supplier pays for part of advertising expenses that feature their product.  Typically the amount they pay is determined by how much you buy.
  8. Use voice over internet protocol (VoIP) to make phone calls, saving on monthly phone bills.  Compare several service providers as prices can vary widely.

The above eight items are not an exhaustive list of ways to cut fixed expenses, but they give you an idea of the range of ways that they can be cut.  So do all of your fixed expenses contribute to the core function of your business?  If not, that's a good place to start cutting fixed expenses.

 

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