There are a couple of good ways to increase profits and cash in your business: increasing prices or cutting costs. Here, let’s dig into how to reduce your expenses.
Note that this isn’t a “one and done” process. Keeping costs down should be an ongoing effort, as there will always be ways to optimize what you do, manage your budget and pay less for services and supplies. Sometimes you’re reducing costs to increase profit margins; sometimes you need to do it to survive. Whatever your desired outcome, we’re here to help.
Here are the steps you should take to begin reducing your costs:
The first step in cutting costs is to understand exactly what you’re paying out. Hopefully, you already have a functional business budget — if not, now is the time to start. Take a look at records of all of the money going out of your business bank account. Look through bills and other payments to identify where you’re spending money and what you’re spending it on.
Gather all this information in a spreadsheet and go back twelve months, so you have an excellent understanding of even your seasonalcash outflows. Double-check the data you’ve collected so you don’t miss anything.
There are three main types of expenses in the average business:
Sort all your expenses into these categories. Once you’ve done that, you will want to subdivide your expenses one more time for each category (per product, operational, hidden). Within each category, you’ll want to sort costs into one of the following areas.
These are the costs you absolutely must pay to stay in business. They might include raw materials for producing your basic products, utility bills, office rental, insurance, legally-mandated costs, bank charges, shipping, some staff costs, etc.
These are the costs that you probably need to pay to run an effective business. They might include marketing and promotion, optional software, some staff costs, etc.
These are the costs that provide “nice to have” options for your business. They might include staff entertainment, some office facilities, charitable donations, extra staff costs, etc.
Now that you’ve categorized all your costs, it’s time to go through them and look at what you can cut. Before you start, you will need to decide how ruthless you have to be. If it’s about the survival of your business, then you may need to be drastic. If you just want to increase profit margins and sustain long-term growth, you can have a gentler approach. Our guide to managing your business budget will help you understand what your financial targets should be.
Almost all of these costs can be cut without dramatically impacting the short-term sustainability of your business. This is the best place to start cutting, so look at reducing or eliminating all of these costs. Cut down on staff entertainment and optional benefits, suspend some office facilities and look at other ways to eliminate expenses.
Look at each of these costs on a case-by-case basis and ask if your business can survive if you do not pay the cost. If you can survive without it, cut it. If you can’t, look at ways of reducing the cost.
There won’t be any essential costs you can eliminate altogether, so you'll have to look at reduction. Here’s how to do that.
Cutting a cost is simple, although it can be painful! To cut a cost, you stop buying particular products or services, lay off a staff member or eliminate the expense in other ways. Reducing costs for essentials (and some optional spending) is a little more tricky. Here are some ways to go about it.
If any of your expenses are “metered,” (utility bills, for example), then look at ways to reduce consumption. That might be as simple as changing temperature settings to lower power usage, or as complex as renegotiating your shipping arrangements based on volume.
For some expenses, you will want to look at reducing scope, or the range of benefits the expense provides. For example, if you have insurance, you might want to reduce coverage or increase deductibles to lower your premiums. In another instance, you could look at your promotional activities to find more cost-effective ways to promote your services.
Many of your hidden costs will come from inefficient business processes, like poor customer service or ineffective marketing campaigns. Spend some time optimizing these areas and you’ll see costs come down and customer satisfaction increase. See our guide to optimizing business processes here.
Take advantage of the competitive landscape and swap out one product or service for a cheaper one. There are plenty of ways to compare prices and features, so you may want to choose a lower-cost option that largely performs the same functions for your business.
Finally, if you buy large quantities of something like raw materials, look at volume discounts. Some suppliers will be willing to reduce prices if you commit to a certain amount of spending.
Cutting business costs is an ongoing process. Once you’ve made changes, keep a close eye on your business budget and see how you’re reducing costs. Track your expenses over the month, quarter and year to see how they’re reacting to your changes. Look for areas where you can optimize further and make a bigger difference if necessary.
These are not your only options; there are several other things you can do to create more free cash in your business.
One tricky thing about cutting expenses: You don’t want to cut back so far that you significantly limit future growth potential, damage staff morale, impact your business reputation or otherwise irreversibly harm your business.
Instead, balance all your cost-cutting decisions against what it means to the medium- and long-term future of your company. It’s better to make a less drastic cut now and protect your business future than cut too deep and damage your long-term plans.
Free cash flow (FCF) is a way to measure a business' financial performance and health. It’s the cash that a business has left over after accounting for capital expenditures and operational expenses.
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