How To Effectively Manage Business Costs

There is an old management adage which says that “you cannot manage what you cannot measure”. This saying may be true in all parts of a company, but is especially pertinent in finance.

We’ve read so much about companies and businesses going under due to poor financial management. By chasing after relentless growth – at all costs – they have gone beyond their abilities to pay spiraling bills to suppliers, employees, and financiers. Other than indiscriminate borrowing, the other “sins” of the leadership and boards of these firms are their failure to respond to the true financial picture of their organizations.

How can one manage one’s business costs better?

First, it is important for all managers to gain some degree of financial literacy. Understand what the difference between profit & loss, cashflow and balance sheet statements are. This should apply not only to senior managers but line managers too.

Second, incorporate reporting processes that mandate not only a reporting of sales and profits but the costs of achieving them. These costs shouldn’t just be the cost of goods sold but should include operating expenses and overheads like utilities, office/shop rentals, salaries, and so on.

A good way of measuring the wider costs incurred in each transaction can be found in Activity-Based Costing (ABC), which is defined by Wikipedia as follows:

Activity-based costing (ABC) is a special costing model that identifies activities in an organization and assigns the cost of each activity with resources to all products and services according to the actual consumption by each. This model assigns more indirect costs (overhead) into direct costs compared to conventional costing models.

Third, invest in business software and systems that helps you to capture costs at various stages. These can range from off-the-shelf small business offerings from Peachtree or MYOB to more complex applications from Oracle and SAP. The important thing is to have a system that can generate a regular cost profile for you as frequently as you need it.

Fourth, aggregate functions and processes within your organization to reduce inefficiencies as much as possible.  These could be as simple as bulk purchases, sharing of administrative staff, and using common IT systems and platforms.

Fifth, ensure that team members are sensitive to the total costs of each transaction. Other than direct costs that goes to suppliers and service providers, indirect costs like time, opportunity costs, and others should also be considered. Reward staff not only for achieving sales or performance targets, but for doing so with the least amount of costs.

Sixth, adopt productive business practices wherever possible. There are a whole range of tools out there depending on your individual circumstances.  They include measuring one’s Cost Of Quality (COQ), reducing shopfloor waste through the application of the 7 Wastes/ and 5S, applying Business Process Reengineering (BPR), Economic Value Added (EVA), and more.

Seventh, examine your entire business process and how the costs can be managed for link in the chain.  These can cover a wide span of activities – from sourcing of raw materials, manufacturing, logistics, packaging, delivery, sales, customer service, to all administrative and office costs.  See if you can fine-tune the system such that costs can be optimized along the entire stretch.

Finally, improve your sales forecasting methods as much as possible.  Now this is probably the hardest to achieve, but some semblance of a pro forma model can be derived by looking at historical records, competitors, and industry averages.

(Image courtesy of Fair Loan Rate)