How to reduce costs and improve profitability

Cutting costs is arguably the quickest and easiest way to improve the profitability of your business. Introducing a cost-control system can bring immediate savings and ensure that you remain competitive in the longer term.

Systematic cost control

Start by identifying your major cost centres. These may be purchasing, production, sales and marketing, finance and administration. Assess your profit and loss statement for the last six months and rank all your expenses from highest to lowest then start working your way down, identifying areas where you could save costs.

Focus on applying cost-saving tactics in areas where you’ll see the most reward, for example:

• Can you save on wages by outsourcing some work, or employing someone on a part-time basis rather than full-time?
• If insurance costs are high, try searching for a new, cheaper supplier.
• Other costs such as long-term fixed rate business loans or fixed price contracts for raw materials are hard to control in the short term. However, make a note of when these are up for renewal and plan to tender out to suppliers.

Comparing actual costs with budgets

Record your actual costs and compare them with the amount allocated in your budget. Try to work out why there is a discrepancy between what you planned to spend and what you actually spend. The larger the cost overrun, the more scope there should be for savings.

Actual costs that are higher than your budgeted costs usually indicate room to reduce costs. Lower costs may indicate good management, but might also reflect a drop in quality or potential problems.

A spreadsheet is an easy way to record and compare costs on a regular basis, such as monthly. Periodically review what you’re doing and how you’re doing it.

Benchmarking your business against other similar businesses may show that your performance is sub-standard. For example, your wastage levels might be higher than the industry average. This is an opportunity to implement cost-saving solutions and to set goals.

Who should be involved?

If possible make each cost the responsibility of one person or manager. Some costs will be easier to control if one person is responsible for that cost throughout the business. Get your employees involved in cost control. Give them an incentive to suggest cost-saving ideas and ask what causes them problems or wastes their time.

Employees are more likely to co-operate with cost-control initiatives if you explain the reasons for changes and they understand the benefits to the business.

Include your customers and suppliers. Once suppliers are aware you’re watching costs, they may start sharpening their pencils, especially if they know the other purchasing options available to you.

Talk to your customers as you may be able to save costs by eliminating unnecessary features or frills.

Some easy savings

There are some costs that can be reduced with little risk of an adverse impact on quality and performance. Some quick savings are:

• Carefully checking supplier invoices for overcharging. Common examples are double billing, incorrect charges and missing discounts.
• Eliminating unnecessary costs. Get rid of obvious overcapacity such as unused telephone lines and computers on after hours.
• Measuring the return on all advertising so you can eliminate what doesn’t work.
• Finding alternatives to high-priced suppliers, or negotiating discounts and better payment terms.
• Avoiding over-specifying, such as high-quality components for a low-quality product.
• Eliminating inefficiency. Identify manual, paper-based systems that could be computerised.
• Avoiding making frequent small orders. They waste time and may mean you miss out on bulk buy discounts.

Other saving opportunities

Taking a systematic approach to all your costs should highlight other opportunities to control costs. In many cases, reducing costs will require you to change the way you do things but be aware of the potential to risk to your core business activities:

• Reduce payroll costs by outsourcing activities.
• Redesign processes to eliminate duplication of effort and time.
• Make more use of technology and automation.
• Consolidate purchasing with fewer suppliers to get better discounts and build strong relationships.
• Agree to long-term supply contracts or annual purchase volumes in return for lower prices and negotiate longer payment terms.
• Trim back your product range and increase production runs.
• Meet with your NAB Small Business Banker to review your finances and reduce interest costs.
• Get the most out of your premises by sub-letting spare space.
• Cut the cost of communications and travel by using email, internet calls (such as Skype) or teleconferencing whenever possible.

Potential pitfalls

Reducing costs can have a negative effect so before you make any changes, check that your standards will not be compromised, and that your ability to meet objectives will not be harmed.

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 driven by cost-cutting considerations are less likely to be responsive to customer requirements.
• Tighter control of financing may leave you with no safety margin when cash flow is unexpectedly poor. Contact your NAB Small Business Banker to ensure you have some financing options.
• Cutting short-term ‘investment’ costs such as training, advertising, equipment or new product development can lead to long-term weaknesses.

Your employee costs

Reducing costs when it will directly impact on employees is a difficult challenge. For instance, reducing training and meeting times is often counterproductive in the long-term.

Poor work conditions, pay and benefits will also not attract and retain quality employees and will de-motivate employees who do stay. Changing an existing employee’s terms and conditions to the employee’s detriment, can be a breach of your legal obligations as an employer, so get expert advice first. It may also damage long-term morale. On the other hand, introducing improved procedures can be difficult and expensive. Employees may be resistant to change and may need extra training.

Speak to your advisers

Finally, remember to include your business advisers, such as your NAB Small Business Banker and your accountant in your cost-control program.

Accountants typically deal with many businesses and are in a strong position to help you identify and monitor ‘cost culprits’ and suggest ways to lower costs and improve business profits.