Tuesday 3 June 2014

The Cost Of Not Costing

People say that being in business is about “making a difference” or about “making a profit”.  These are good reasons and are the reason that businesses stay in business.   as well.  What people forget is that being in business is about making sure that the money coming in exceeds the amount going out and that it comes in at the right time. 

I recently tweeted that failing to plan financially is planning to fail financially.  Not only should you plan ahead to make sure that you will always have sufficient resources to cover expenses as they fall due, you should also look at your pricing.

I recently saw a case of a successful business which won a new contract from a large client.  When I asked about what equipment and changes they would need to pay for, the owner said that he would have to “watch costs”…

Why?  When I took him through the likely costs of doing business with that client, it was clear that he had based his pricing on his desire to get the business, rather than on what it might actually cost him in terms of property, equipment, staffing and other expenses.  

He also assumed that the fees from the new business would start when the client said they would.  As it was, the client delayed the start of the contract by several months, meaning that the business incurred costs up front, but had to use its own cash to cover them, leaving much less available for its existing activities.

Finally, he hadn’t left any margin for error or unforeseen costs.

Result?  He needed to penny-pinch to make things work (I won’t say profitable).  It meant delayed purchases of equipment that was needed, demoralised staff and a client who wasn’t impressed.  Had there been a problem, the contract would have been barely profitable, and he risked losing money.

So do you avoid this?  First, set up a simple spreadsheet with months of the year across the top (with a total at the end) and then work out your costs, e.g:
  • Rent
  • Utilities
  • Staff
  • Other services/support costs 
  • Cost of new equipment
  • Contingency

Depending on your business, you may add others, or some of the above may not be relevant.  Put the different costs down the left side of the sheet.

Next, are the costs monthly, quarterly or even annual costs (you might, for example, need to renew a particular permit every year in April)?  Adjust the spreadsheet (or get your accountant to help).  In the case I witnessed, the business’ bookkeeper wasn’t able to support the boss (and the latter wasn’t interested in details like this, he just wanted the business).

Once you’ve got your spreadsheet set up with the costs in the proper places, look at what you need to charge just to break even.  You may be charging them a flat fee per transaction per event or per month.  Work out what the result will be.  Underestimate rather than overestimate.  Your breakeven is the minimum you can charge.

You need to understand what you’re likely to make per month and when you will actually get paid.  Remember, you will incur certain costs during the month, but if you give credit terms, you won’t get paid until later.

Once you think you have a realistic view of:
  • What costs you will incur and when AND
  • When you will actually receive payment

Subtract each month’s costs from the payments you expect for that month only (so you may be subtracting January’s costs from payments arising from December’s activity but received in January).  Until the new business is working properly, you may have a shortfall to finance.  Your spreadsheet will show you this very quickly.

If you have a shortfall, how will you finance it?  Do you have the cash available in the bank, or will you need an overdraft?

The beauty of this approach is that you can play with any number of cases to see how things change.  What happens, for example, if you only do half the business that you thought you would?  Or if your costs change for some reason?

Whilst this exercise may seem tedious and time-consuming, it’s better than the potentially longer (and more stressful) time you may have to spend desperately looking for emergency cash when things go wrong.  You can also show it to your banker (or anyone else whom you approach for finance) to prove that you have thought things through and allowed for contingencies.

I have spent more than half my life delivering change 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 to offer solutions for improving performance, productivity and risk management.  I 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.  For strategic questions that you should be asking yourself, follow me at @wkm610.


Labels: , , , ,

0 Comments:

Post a Comment

Subscribe to Post Comments [Atom]

<< Home