Surface Ripples

Tools For Effective Cost Management

Every business needs to understand not only what its costs are and how they arise, but also whether they’re “normal” for the particular business concerned. This is where a good finance team, book keeper, accountant or even your own knowledge of the business’ numbers comes in.

The first tools are budgets (or forecasts) and reviews. A number of businesses don’t bother to forecast what they think they will spend – especially in good times. However, if you don’t do this, how will you know if the business is “on track” or not? A forecast need not be highly complex and it can be refined as the year progresses and more information becomes available. Banks will always ask for forecasts when deciding whether to lend, so you should have the latest actual and forecast numbers available.

The review is just what it sounds like - a review of what you have done against what you thought you would do. It helps you refine forecasts and make more informed decisions.

Another tool that banks use to make lending decisions are ratios. These cover any number of aspects of the business, but as a minimum you could use:

1. Gross Profit Margin:
This is your profit after costs of sales (purchases, direct advertising, sales commissions) but before overheads (e.g. rent, utilities, salaries, etc) divided by your total revenues. The answer is expressed as a percentage and shows how effective the business is at selling its products or services. In isolation, the answer is helpful; taken month by month or year by year, it will show a trend which can then be investigated.

2. Operating Profit Margin:
This is your profit after both costs of sales and overheads have been paid, divided by revenues. The answer shows how efficient the business has been in selling its products or services. Trends can be investigated to understand what may be getting better (or worse). If the percentage is decreasing, it means that costs are going up and that you may need to take action, depending on the reason.

3. Retained Profit Margin:
This is the final profit left after all costs (including tax, interest and depreciation) have been met, divided by revenues. The answer shows how much cash is left in the business to support further growth.

4. “Burn Rate”:
The “burn rate” is how much actual cash goes out of the business every month to keep it going (i.e. overheads, interest costs, depreciation). This is what the business has to earn as a minimum every month just to cover its costs after meeting costs of sales. Some say that depreciation shouldn’t be included as it is not an actual cash outflow, but if you want to be cautious, keep depreciation in as you will need to replace equipment, vehicles and other items.

5. Sales to Number of Staff:
Found by dividing revenues by headcount. If the answer increases or decreases (particularly the latter), find out why.

6. Costs to Number of Staff:
Found by dividing overheads by headcount. If the answer increases or decreases (particularly the latter), find out why.

A knowledge of these as well as any others that you find useful in your own business is vital in knowing how the business is performing (which you can discuss with staff, investors and lenders) as well as being a source of early warning if things are starting to go wrong.

I have spent more than half my life working in different world markets from the most developed to “emerging” economies. With more than 20 years in the world financial services industry running different service, operations and lending businesses, I started my own Performance Management Consultancy and work with individuals, small businesses, charities, quoted companies and academic institutions across the world. An international speaker, trainer, author and fund-raiser, I can be contacted by email . My website provides a full picture of my portfolio of services.

Labels: Crisis Management, Financial, Productivity, Risk, Strategy

posted by William Martin @ 17:27