From the smallest proprietorship to the largest international conglomerate, cutting costs can often be perceived as a “quick fix” toward improving financial results. However, such business decisions may not always be in the best long-term interest of an otherwise healthy company.
Many business owners react to unexpected pressures by reducing costs without a definite plan of action; their course is reactive instead of proactive. However, this “strategy” may become random and shortsighted unless it’s based on a company’s business plan. While an immediate need may appear to have been alleviated, in some cases only the symptoms – rather than the real problems – may have been addressed.
A better plan of action focuses on managing rather than simply cutting costs. The difference is more than a matter of semantics. Managing costs is the proactive process of consciously choosing to spend in areas designed to produce a positive financial result, while cutting costs is a reactive process, which typically happens when things seem to be getting “out of control.”
While both strategies entail eliminating waste, effective cost management relates costs to profits, whereas cost cutting is not necessarily closely correlated to profits. A haphazard approach can result in the illusion of a better bottom line, when in fact productivity and profitability may suffer.
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. Or, your business might depend on a combination of products and/or services. Once you understand your revenue structure, you must become aware 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? Are there extra or unnecessary steps in the process? Are people communicating effectively?
- Encourage Employee Involvement. Most employees have expertise in what they do because they do it every day. Establish rapport by seeking their advice and tapping into their creativity. Ask your employees for input into the decision-making process. By soliciting their suggestions on how to deal with specific cost problems, you will be giving them more incentive to become part of the solution.
- Assess Decisions Against Your Strategic Business Plan. Cost management decisions should be measured against your long-term business strategy, rather than within the confines of a short-term situation. 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 to satisfy your customers? How will your cash flow be affected? Will you be stuck with excess inventory if the market changes unexpectedly?
Discipline Can Pay Off
In our competitive and unpredictable economy, the need for efficient and effective cost management is a necessary ingredient in developing and fostering a successful long-term business. By knowing your true costs, and linking them to the bottom line on an ongoing basis, you will be in a better position to balance the varied and competing pressures for your financial resources.