Some take it more seriously than others. Major conglomerates, such as Hanson and BTR, have made their reputations and fortunes on their ability to reduce and then control costs in any business they manage. They rarely fail. In your own business there is the added motivation that the money is your own - all you have to do is persuade everyone else in the business to treat your money as if it were their own. This is difficult. You don't want to appear to be a perpetual Scrooge figure, carping over the costs of pencil sharpeners, but you must be constantly aware of where the money is going. This requires tight financial reporting mechanisms. Hanson and BTR are expert at extracting vital information, quickly and efficiently and then, just as important, acting on it. If there are the slightest signs of costs running out of control they act quickly.
Fixed costs are incurred for things that you have to pay for no matter what the parlous state of your finances. They do not go up and down according to the volume you produce. These include:
- insurance
- rent
- rates
- utility bills - lighting, heating, water.
- labor - labor costs once formed the major part of fixed costs, but, with a growing pool of flexible, part-time and temporary workers, they are now likely to be more variable and can be managed according to how busy you are.
Variable costs include buying raw materials, stationery and office supplies. These generally increase as your turnover increases. Controlling them is a crucial factor in increasing your profit margins.
Having examined your cost structure you can break down the total costs of the business into key elements. Once broken down these can be compared with those of competitors, if available, and monitored and measured more easily.
Clearly, it is important that you keep the fixed costs as low as possible and that variable costs are as flexible as possible. This simple intention can be confused by a number of things.
- Long-term purchasing contracts. You need to exercise extreme caution over long-term commitments. In particular, beware of fixed price contracts. Long-term fixed price contracts without renegotiation clauses have left many companies facing heavy losses when their own costs mount.
- Employing people. People are expensive assets. The pros and cons of taking on more people needs to be carefully weighed.
- Too large premises. When times are good it is tempting to move to bigger premises. Indeed, you might move into an extremely large building in expectation of your business growing even more. This can prove disastrous.
- Too large stocks. If sales are increasing, it is tempting to produce as many products as you possibly can. You are confident that you will quickly be able to sell your stock. This may happen. But what if business slows down and you are left with a warehouse of products which you simply can't sell? You need to constantly monitor the size and value of your stocks. If you allow them to get out of hand, you may be left with selling them at a loss.
- Unrealistic targets. Many of these problems can be caused by setting targets which are unrealistic. If you are overly optimistic you might produce too many products or move to premises which are larger than your business actually merits. Similarly, overly pessimistic targets can mean that you are simply unable to produce enough to meet orders. It is important to try and be realistic. This is difficult, but can be helped by involving as many people as possible in setting the targets; recruiting a balanced team (a team of hopeless optimists isn't suddenly going to become a group of hard-nosed realists when they look at next year's targets); ensuring that you receive accurate and timely information on all aspects of your business's performance.
Inevitably, there is a catch to all this. Minimizing costs is important, but can create businesses which are conservative and reactive. They fail to emphasize innovation and react to events rather than taking a lead. Instead of investing in research and development or training and development they concentrate on competing on price alone. This can be shortsighted. Costs must be controlled, but they must also balance the short term and the long term. If you control costs tightly in the short term, you may create a situation in the long term where your products have failed to move on with the changing needs of customers; your people haven't developed appropriate skills; and you are regarded as a business which is more interested in price than producing quality goods or services.
