Cost Cutting the right way
“My dear young friend,’ said Mr. Micawber, ‘I am older than you; a man of some experience in life, and – and of some experience, in short, in difficulties, generally speaking. At present, and until something turns up (which I am, I may say, hourly expecting), I have nothing to bestow but advice. Still my advice is so far worth taking, that – in short, that I have never taken it myself, and am the’ – here Mr. Micawber, who had been beaming and smiling, all over his head and face, up to the present moment, checked himself and frowned – ‘the miserable wretch you behold.”
“I say,’ returned Mr. Micawber, quite forgetting himself, and smiling again, ‘the miserable wretch you behold. My advice is, never do tomorrow what you can do today. Procrastination is the thief of time. Collar him!”
This wonderful excerpt from David Copperfield by Charles Dickens summarises the biggest problem when cost cutting. People will talk about doing it but for very important reasons never actually get around to it. There is always a good reason why they put it off. A new sales push, problems to solve, people to meet… just no time. But if you are going to succeed in a serious cost cutting exercise you must take the time to do it properly and thoroughly.
Ok so you have decided to get started but where do you start. The first thing you must do is to identify what your real costs are and exactly when they occur. How do you do this accurately? You could analyse your bank statements but these can be more confusing than helpful. Your expenditure leaves your account over a number of different time periods such as weekly, monthly or even annually. When are these expenses supposed to leave your account and when do they actually leave your account because this can be very different? Looking at your bank account in isolation will not give you a full picture of your costs.
So why not look at the accounts prepared by your accountant? Surely these must be an accurate reflection of what is going on? Well not necessarily. The profit and loss account is likely to cover a twelve-month period and therefore seasonal trends are hidden. Income and expenditure may be higher or lower at different times of the year and you need to know exactly when these occur. Your profit and loss account statement also generally only includes tax-deductible expenses but there may be other costs you are incurring which are not being shown. Consider the hire purchase or loan costs on that car or piece of equipment you need. Only the interest is shown in the profit and loss account. The capital repayment is to be found reducing the liability on the balance sheet.
There may be other items of expenditure, which appear on the balance sheet instead of within the profit and loss account. Fixed asset additions appear on the balance sheet and only depreciation appears in the profit and loss account. The depreciation seldom reflects the actual costs as the depreciation rates can vary from 10% to 33% depending upon the asset type. Don’t forget some annual costs could occur both at the beginning of a year and at the end so could be counted twice or not at all.
So as you can see identifying what your real costs are is not that simple and you need to spend time right now in preparing a detailed cash flow statement on the basis of moving forward without cutting costs to give you the likely picture if you do nothing differently. The purpose of this cash flow statement is to increase the pressure on you to cut costs so although when preparing this cash flow analysis you want to be as accurate as possible, if you have to make an estimate make sure it overestimates the likely cost. You need to see the worse possible scenario if you continue to spend at the current level. This will increase the “misery” and make you commit to cutting costs in order to survive.
“My other piece of advice, Copperfield,’ said Mr. Micawber, ‘you know. Annual income twenty pounds, annual expenditure nineteen (pounds), nineteen (shillings) and six (pence), result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.”
Ok so lets assume you have prepared your cash flow analysis for the coming year. Notice I have not called it a cash flow forecast because you are going to make fundamental changes to your costs before you convert it from an analysis to a forecast. Also a forecast includes turnover whereas you are not interested in turnover at all at this stage. It is only about costs and expenses and nothing else.
All of the high street banks can supply cash flow forecasting material so use it. It is a simple format and there is no need for me to repeat it here. The only thing I would remind you is that you must do it in real detail and not in summary form which some systems encourage. Do not spread payments over twelve months in the forecast if you pay them four times per annum. Do not use one heading for light and heat if you have both gas and electricity costs. Use two. You need lots and lots of detail at this stage.
The next step is to decide which group of expenses to attack first. Should you choose direct costs (costs of sale) or indirect costs (overheads) to cut first? You are likely to have limited time and resources so you will want to achieve the greatest improvements in your profitability in the shortest time scales. Rather than using a scattergun approach and start slashing costs wherever and however you can, you should look for those costs that will have the greatest effect on profitability and work downwards from there to the smaller ones.
We have developed a whole bunch of tools and resources to help our clients cut their costs without being detrimental to the future success of their businesses.