Managing the Costs in your Business

Cutting costs can be a simple way to improve your bottom line. Introducing a cost control system can bring immediate savings and ensure that you remain competitive in the longer term.

But cost control needs to be carefully managed. While eliminating wasteful activities is clearly beneficial, indiscriminate cost cutting can lead to falling quality and poor morale.

Identify your costs

Cost control works best as part of your routine financial management. The first step is to look at your existing costs.

1. Identify your major cost centres. Typically these might be purchasing, production, sales and marketing, financing, administration, premises, facilities management and R&D.

2. Identify the major types of cost within each cost centre.

These might include staff costs, raw materials and supplies, utility bills for energy and water, capital expenditure, other purchases (eg consultancy services and advertising space), premises, telecoms, travel, transport and financing costs.

3. Choose the costs to focus on first.

• Costs that may offer easy savings.
• Large costs that you may be able to change in the short term. Please note that some fixed costs (eg long-term fixed rate loans or fixed price contracts for raw materials) are hard to control in the short term.

Some cost centres, such as R&D, make important but indirect contributions to your bottom line. You need to account for these contributions before deciding whether to cut their budgets.

Systematic cost control

1. Start from your business objectives.

For example, you might aim to manufacture 1,000 units per month, or to win ten new customers.

Ask yourself...What are your quality standards? If you are to increase production your customer service standards might require a trained employee to respond to all enquiries within a specified time.

2. Establish your ‘standard costs’ for achieving your objectives.

Standard costs are the costs you would have in an ideal world.

You need to consider:

• What resources you need. For example, components of a specified quality or staff with specific skills.
• How much of the resources you need. Standard costs assume optimum performance (eg no unnecessary wastage of raw materials or staff time).
• What the resources cost.

3. Establish realistic ‘budgeted costs’ based on your actual experience.

• Budgeted costs will usually be higher than standard costs. For example, you might expect 2 per cent of all production to be wastage (including substandard goods), raising unit costs.
• Budgeted costs may sometimes be lower than standard costs. For example, your customer service staff costs may be lower than the standard cost, because you are currently using fewer, lower paid staff.

4. Record your actual costs and compare them with the standard and budgeted costs.

It may be appropriate to compare unit costs (cost per unit produced) or total costs (including overheads such as premises).

• Costs that are higher than your budgeted costs may indicate opportunities to reduce costs in the short term. In general, the larger the cost overrun, the more scope there should be for savings.
• Costs that are higher than your standard costs usually indicate opportunities to reduce costs in the longer term.
• Lower costs may indicate good management, but might also reflect quality failings or impending problems. For example, costs can be cut in the short term by cancelling all training – at the risk of causing longer-term skills shortages.

Using a spreadsheet or cost control package, it is easy to record and compare costs on a regular basis (eg monthly).

5. Periodically review what you are doing and how you are doing it.

• Benchmarking yourself against other organisations may show that your performance is sub-standard. For example, if your wastage levels are higher than the industry average.
• Internal review, or input from an external consultancy, may suggest alternatives. For example, standardising components to reduce design and manufacturing costs.

Who is involved?

Some costs can be easier to control if one manager is responsible for that cost throughout the organisation. For example, concentrating all purchasing can make it easier to achieve economies of scale.

1. Involve employees in cost control.

• Employees can suggest cost-saving ideas, especially if there is an incentive to do so. Ask what causes them problems or wastes their time.
• Employees are more likely to co-operate with cost control initiatives if changes are explained to them.

2. Include your customers and suppliers.

• Ask your customers if you are providing them with anything they do not need.
• Your suppliers will know what other purchasing options are available that might suit your business.

3. External consultants can be a useful resource.

External consultants can offer an advantage over purely internal cost control.

• Consultants may have up-to-date, specialist knowledge. For example, they may be acquainted with up-to-date benchmarks for your industry and current market conditions for utilities and other suppliers.
• A consultant’s thinking may be able to avoid being influenced by vested interests and historical preferences within your company.

4. Select a consultant carefully.

• Look for membership of an established and appropriate professional body, with a published code of conduct.
• Check references and look for evidence of a good track record, working with businesses comparable to yours.
• Find out about the consultant’s financial standing and check that there is indemnity insurance cover in place.
• Consultants may have specialist expertise in particular areas (eg production engineering or energy costs).
• Negotiate a clear, written contract.
• Agree what you will pay. If fees are to be based on a percentage of savings, agree how these savings will be calculated.
• Arrange when you will pay.
• Avoid having to make upfront payments, before you can see the results of a consultant’s work. Insist that the consultant signs a formal confidentiality agreement.

Pitfalls

Reducing costs can be damaging if undertaken without due consideration. Before making changes, check that your standards will not be compromised and that your ability to meet objectives will not be harmed.

1. Reducing costs which directly impact on employees is fraught with difficulty.

• Employees are not machines.
• Reducing costs such as training and meeting times is often counterproductive in the longer term.
• Introducing improved procedures can be difficult and expensive.

2. Employees may be resistant to change, and may need extra training.

• Poor conditions, pay and benefits will not attract and retain good employees.
• Changing an existing employee’s terms and conditions, to the employee’s detriment, can be a breach of contract.
• Making employees redundant can save on short-term costs but run the risk of possible legal action. It may also damage morale among those who remain.

3. Almost every cost saving has a potential downside. For example:

• Over-dependence on one supplier puts you at risk if the supplier fails.
• Production and marketing plans that are driven by cost-cutting considerations are unlikely to be responsive to customer requirements.
• Tighter control of financing may leave you with no safety margin when cashflow is unexpectedly poor.
• Cutting short-term ‘investment’ costs (eg training, advertising, equipment or new product development) can lead to long-term weakness.
• Attempting to control unalterable costs is itself a wasteful process.

Cost control is an essential part of good business management and we are always available to assist your business address this important issue.