By Marian Kneitz - Friday, July 3rd, 2009

As a business owner, you are acutely aware of the importance of maintaining positive cash flow. But just because you’re in the black, it doesn’t mean your costs are being managed as effectively as they could be. And if the bottom line is under pressure, taking a hard look at costs can make all the difference in preventing a slide into the red ink.

The Issue

You’ve been in business for a few years, maybe longer, and have been rightfully focused on building it up and growing sales. You know you have been successful because there is always money available at the end of the day. But growing sales is only one side of the profit coin – the other is management and control of costs and expenses. Managing and reducing costs to optimize profit margins gives you a competitive edge, and especially when times are tough, better leverage.

Businesses that take steps to ensure their operations are as lean and efficient as possible in tough times are not only more likely to survive, they will emerge that much stronger when conditions improve. But to understand where there may be fat to cut, you must first understand your cash flow and your financial business model – what your business looks like in terms of revenues and costs.

What to do?

For starters, get your accountant to provide you with a Profit & Loss (P&L) statement and identify and explain what flows into each line/cost item. Challenge everything and anything. Does each item make sense to you and align with your understanding of your business? Do you understand what are fixed costs, variable costs, direct costs and indirect costs? What ability do you have to influence them – in the short term, in the long term?

• Look at ratios, percentages and margins. Review labour costs as a percentage of sales; cost of goods sold as a percentage of sales and gross margins. Regard ALL line items as a percentage of sales. After all, it is your sales that pay the bills for everything else in your business.
• Perform a trend analysis on historic data with side-by-side comparisons of spreadsheets that show P&L, with the ratios and percentages, for each year. Look for any changes in ratios over time, find out the reasons for these changes and determine if the changes make sense in light of your business development. Address any that don’t!
• Benchmark ratios and margins against other successful businesses in your industry. Draw on your accountant’s experience, your peer network, and data from chambers of commerce, market research firms, or professional associations (such as retail and manufacturing associations, depending on the business and industry your are in). See if you are under-performing relative to these benchmarks. If so, do you know why, and what can you do about it. If you are doing better, can you leverage this advantage?
• Prioritize your costs/expenditures. Divide everything into two lists – Must Haves versus Like to Haves that are not necessary. Get rid of any items that are not necessary to the operation of your business and ensure you have the right controls in place to keep them out. A lot of hidden costs can creep up in this category – such as interest on outstanding credit card payments, banking fees, travel and entertainment. Many of these items may be slumbering under “Miscellaneous,” so monitor this line item to keep it in check. You can look at optimizing some processes around these (such as banking fees) and balancing them against cash flow requirements. Employee expense claims in particular can be an area where poor oversight can quickly lead to weaker margins.
• Set targets and make budgets using a planning tool with monthly, quarterly, or annual P&L statements. Identify whatever strategies you need to meet the targets and implement them. This includes optimizing processes such as approving and paying invoices. Are invoices circulating for days before they can be approved and paid? Are you making the most out of early payment discounts? Consider a purchasing order process. Many accounting software packages already include modules for this, otherwise it can be done with Excel. There are two benefits:

i) Purchases are approved upfront, prior to the invoices arriving, making invoice processing much faster.

ii) It gives you that much more transparency on upcoming expenses and payments, and therefore more flexibility to be pro-active in managing your costs (and cash-flow).

• Consider using credit cards as a method of payment wherever possible and collecting points that can be used to cover travel costs. But always be sure to pay off credit card bills when due. Cover any cash-flow deficits with a line of credit, not via expensive credit card interest rates.
• Move payroll as much as possible to a monthly cycle and electronic payments. 
• Challenge suppliers for better terms and switch fixed costs to variable ones. Take a good look at any flat rate fees you pay, especially for services, and the volume and frequency of use of these services. Are you using all that you are paying for, or would you be better off arranging a more discretionary use and payment? Track your performance and analyze variances to ensure you understand them and they are justified.
• Lastly, involve your employees. The expense claims cited above is only one example of the myriad ways that employees can impact your cash flow and the costs that eat into profitability. Ensure they have a clear understanding of the influence they have, both positive and negative, on the overall financial health of the organization.

Category: Expert Advice.
Industry: Retail, Technology, Services
Functional Area: Finance
Tags: cash flow, cost reduction, employee expenses, inventory management, line of credit, managing costs, P&L, payables, payroll, profit and loss, profit margin, receivables, revenue, trend analysis