Corporate Cost Cutting: Is it Possible to Implement and Increase Revenue?
Jared Newman
Seat F-2
5-12-04
Corporate Cost Cutting:
Is it Possible to Implement and Increase Revenue?
Any corporation in the world will agree that their long run goal is to maximize profit. In today's fluctuating and unpredictable economy, however, more and more corporations are looking to their quarterly income statements only to realize shrinking revenue and even net loss. Cost cutting becomes an inevitable alternative and a more tricky proposal than meets the eye. Saving on expenses is a key component of profit enhancement. Many corporations over the past few decades have run into distressing problems when trying to implement cost cutting policies, many of which ended with equally devastating results. Limiting expenses overnight is not an effective strategy. It may take months to lay the groundwork for efficient cost cutting methods. But where to begin? When does the cut go too deep? How will you know if you've trimmed off only fat and no muscle? These are all aspects that must be taken into consideration when structuring a policy. Ultimately, a systematic approach to shedding costs will help any corporation run business more efficiently while increasing the bottom line results on future income statements.
Additional costs are a part of every new sale. However, costs can grow
out of control if you don't regularly monitor and contain them. Are corporations nowadays managing for profits through ongoing and systematic cost cutting? If not, they are foregoing a key component of profit enhancement.
Theoretically, for each sale, they might incur the expense of sales
personnel, trucks that deliver the merchandise, billing clerks that send
invoices and statements, and collection people who become involved when
accounts aren't paid on a timely basis, to name a few. Add it all up and
a company's expenses can be substantial.
Look at the bottom line of any large corporation's income statement as a clear indicator of just how small a portion is theirs of each dollar of additional sales.
Many business owners consider themselves fortunate if the company has a
0 percent net income. Wouldn't it be great to make more? Consider this: for a company to earn $100,000 of additional profit, it would need to boost sales by a million dollars, assuming they are bringing 10 percent of sales to the bottom line. Do all businesses have the financial resources to handle the costs associated with the additional volume of sales? Could they afford the additional equipment, personnel and other overhead associated with a significant increase in sales volume? Probably not. is
there another ...
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Many business owners consider themselves fortunate if the company has a
0 percent net income. Wouldn't it be great to make more? Consider this: for a company to earn $100,000 of additional profit, it would need to boost sales by a million dollars, assuming they are bringing 10 percent of sales to the bottom line. Do all businesses have the financial resources to handle the costs associated with the additional volume of sales? Could they afford the additional equipment, personnel and other overhead associated with a significant increase in sales volume? Probably not. is
there another way to increase profits? There certainly is.
With sales held constant, for example, let's examine a fictitious company's
simple income statement to realize the dramatic benefits of cost-cutting.
Prior to Cutting Costs After Cutting Costs 10%
Sales $20,000,000 $20,000,000
Cost of Sales 10,000,000 9,000,000
Gross Profit 10,000,000 11,000,000
Operating Exp. 8,000,000 7,200,000
Net Profit 2,000,000 3,800,000
As an alternative to increasing sales, cutting costs by 10 percent alone
(both the cost of sales and operating expenses) could almost double this company's net profit to $3.8 million. Net profit increases from 10 percent of sales to 19 percent solely through cost-cutting. In order to increase net profits to $3.8 million without cost-cutting,
sales would have to be increased to an incredible $38 million -- a 90 percent increase. Imagine the effort and cost associated with increasing sales by that much. Many companies couldn't afford to grow to nearly twice their existing volume because of insufficient working capital. Furthermore, a sale at the first of the month might not produce cash for 60 days or longer. In fact, sales may need to be greater than $38 million at this particular company because the costs associated with financing the increased sales activity and accounts receivables could be substantial.
To be sure, there are savings associated with greater volume, and
typically, all costs don't have to go up in proportion to an increase in sales. However, when there is significant sales growth in a company, profits are often minimized because of the substantial strain on the company's resources. Keep in mind that there is no additional cost associated with decreasing expenses. Cost-cutting is an attitude and an activity to pursue vigorously. Once implemented, it can provide immediate bottom-line
results. Cost-cutting requires less effort than producing additional sales and the savings are often significant. The savings derived from cost-cutting puts no financial strain on the company when implemented properly. Also, there is no need for additional equipment, personnel, interest to finance additional bank debt, or other overhead associated with the
increase in sales volume.
Now that it is established that cost cutting is an effective way to increase net income, we must explore techniques to actually cut cost. This is where it becomes tricky. A good first step is to look at gross profit margins. If the margin has been deteriorating, the company must find out why. They have to look to determine if increases in direct costs can be passed along to the customer. Next, the corporation must analyze the product to see if it can be reformulated or redesigned for cost savings. If the sales staff is compensated on gross sales generated, they should consider changing the policy to account for the quality of sales (consider paying commissions on the gross profit in a sale.) If the corporation, for example, sells a number of different products, determine their individual gross profit margins and their mix. Give particular attention to low-margin products to see if it's still worthwhile to carry them. If it isn't they need to weed them out and bring in products with a higher marginal profit.
Perhaps the most important single issue in any large company is payroll. Payroll costs are a major item in most businesses. Possibly a more efficient plant layout would result in reduced labor needs. Similarly, automation should be explored where practical. The initial investment may be costly, but more than offset by future payroll savings. They should consider the use of temporary employees and subcontractors if the business is subject to seasonal variations, as many businesses are (especially here in Connecticut). Payroll-related costs are fertile areas for cost reduction. Fringe benefits can easily amount to 25-50% of direct payroll. Any company should also review employee classifications for workers' compensation insurance. Improperly classified workers can be costing them significant premiums. Similarly, they should review group insurance programs and solicit bids for the programs every three years. And finally, the firm should consider higher deductibles as a means to lower premiums.
Another costly expense to remedy could be Considering getting rid of company-owned autos. With the extended depreciation periods, it takes longer to recover their cost. It may be easier to reimburse the employees for business use of their personal cars. Alternatively, a company has an option of leasing the vehicles.
Something just implemented at my place of business is reviewing credit policies. The longer it takes to get paid, the greater the risk of loss. The 80/20 rule states that 80% of a company's revenue is generated by 20% of their customers. If this is the case, it may be wise for them to review the other 80% of their customers to see if they can continue to serve them cost-effectively. Otherwise, their time will be better spent soliciting new clients.
Analyzing inventory levels is another cost effective measure. Determine if any obsolete inventory can be reworked or sold for salvage. Also using a perpetual based system for inventory is much more efficient than counting 100% of the product and wasting time and a day of potential sales.
An additional approach is to review fixed assets. Any corporation should consider disposing of excess machinery and equipment. Determine whether it would be better to buy or lease major assets, especially those subject to rapid technological change and those assets used infrequently. This goes hand in hand with reviewing purchasing policies and costs of supplies, product, or raw materials. Compare prices of other suppliers. Switch suppliers where appropriate, or renegotiate for better prices with your current suppliers.
Using prior financial results as a guide, a corporation should prepare budgets and long-range projections. Actual results should be compared to these projections to highlight areas needing attention before material problems develop. Budgets and projections can also be used to determine the impact of proposed changes in sales, gross margins, and expenses before they occur, allowing the company to act instead of react.
Finally, any business, big or small should enlist the aid of employees by soliciting suggestions on cost reduction. Many companies have generated significant savings using this approach. To encourage participation, consider implementing a bonus program based on a percentage of costs saved. Be wary of "quick fixes" that will have no impact, or worse, prove costly in the long run.
As you can see, cost cutting is an efficient and effective way to weed out those unnecessary or inefficient expenses and immediately increase net income in corporations. While it is a delicate procedure with monstrous negative implications (if not planned appropriately) it can be a tool implemented in corporations, partnerships and proprietorships with success.
