Does Your Company Use Best Practices In Cost Reduction?

Why is it that companies only decide to cut costs when the economy hits a roadblock? All those things we knew we should have looked at, knew were a problem, but simply didn’t have the time, or in some cases, even chose to ignore, suddenly become the priority when times are tough.  When everything suddenly stops, and demand falls, only then do we decide to try and improve things and reduce business costs. However, doing the right things is something that must be done in good times, and in bad.

While we may learn these lessons the hard way, they are important lessons to learn. Many companies that adopt best business practices have some story behind why they decided to change. It’s these bad experiences that help shape our future. Look at this current economic situation as a learning experience and ask yourself if yourcompany uses best practices in cost reduction? 

Manage Both Fixed and Variable Costs

I’ve come face to face with this situation on a number of occasions. Companies tend to think their fixed costs are fixed and set in stone. They are not set in stone! To summarize fixed and variable costs, here’s a quick definition, followed by some ideas on how to reduce each:  

• Fixed Costs: These are your employee’s salaries, your rent for your building, the interest paid on business loans, and the monthly payments you might make on equipment or other capital expenditures. While they are fixed, they are fixed for a given period of time.

• Variable Costs: These are the costs that are associated with volume produced or made. What do I mean by that? Well, if you make more of something, you’ll buy more of those parts and materials needed to make those parts. Therefore, these are variable costs. They vary according to their usage. Your variable costs are the materials and products you buy, and perhaps the heating and electricity.

• Total Costs: You guessed it, your total costs are simply your variable and fixed costs combined.   

 

While this might seem rudimentary to some, for others, it helps put everything into perspective. Take the time to track the results of your actions. In fact, it’s the absolute most important aspect of reducing your costs: - tracking your results is paramount to success. If you want the excel sheet where this graph comes from, here it is:  Download Sample-fixed-variable-total-cost-excel-sheet

Can You Change the Value of Your Fixed and Variable Costs?

 

You won’t be paying for that equipment forever, and perhaps won’t always pay the same interest rate on your loans. In addition, your overhead is one area where you can have a drastic impact on your fixed costs. While this decision is never popular or easy, it is a necessary evil. Now, I am not advocating hiring and firing whenever it suits you. What I am saying is that the best companies won’t allow their overhead to impact their gross profit margins, or their bottom line, for too long before making an adjustment. So, what could you do to improve your fixed costs?

 

Turn Fixed Costs Into Variable Costs: When it comes to using best practices in cost reduction, several companies turn fixed costs into variable costs. How is this done? Several companies decide to outsource their marketing to a marketing firm. The savings over having a full time position are quite substantial. Other companies may decide to use temporary employment contracts for production, shipping, accounting and inventory management, or any other function.

While having to let someone go is never a popular move, the difference between a full time position, and outsourcing some of your company’s needs, is often too much to ignore. The difficulty is reducing the scope of the job without reducing its impact. While there are savings to be had, if that decision affects your service levels, then it’ll cost your company in the eyes of your customers. Finding a balance is key.

 

The benefit of outsourcing your marketing, or other functions, is that it allows your company to better manage the results of your initiatives, and better manage your costs. Have a new marketing idea? Try it out first with a marketing firm and gauge the results. Need to hire part time employees for production for a big job? This is especially good when you have a large job, but not quite sure if it will become repeatable business. Other ways to turn a fixed cost into a variable one include.

 

 

Most of the items on the above list are similar to increasing your return on assets. Performing a ROA analysis is a great way to find alternative revenue sources while reducing costs. To learn more please go to: Business Asset Management: Maximizing Company Assets With an ROA Analysis

 

You might look at the above, and not be convinced of their effect. So, to put it into perspective, think of the following answer to this question: “How much does it take your business to generate $1.00 of net profit?” What’s your answer?  Is it $10.00 of sales, $8.00 of sales? The point is, every dollar you save or reduce in costs, goes directly to your bottom line. In this case, that $1.00 saved is equal to $10.00 or $8.00 of sales. Think of how much effort goes into generating that $1.00 of profit.

 

Reduce Your Fixed Costs: Wonder how you can pay a lower interest rate on your business loans? The answer is pretty straightforward. Pay you invoices quicker. Now, I know that paying on time is not always easy, but I’ve seen plenty of companies who delay payments on invoices because they think they can get more in interest by holding onto the money. Sure, sometimes it’s all about cash flow. Your company doesn’t get paid fast enough, and you can’t pay your own bills.

 

Don’t make the mistake of holding off on paying your invoices on time, because you think you’ll make some interest on it yourself. There’s a little thing called a D&B Report. I am sure you are aware of it. In any case, the interest you pay on your loans has a lot to do with your credit rating, and how your suppliers/partners, rate your company in terms of payments.   In fact, when your company is in excellent standing financially, you’ll get the best possible interest rate, so shop around.

 

Reduce Your Variable Costs; I could go on forever about how to reduce your variable costs, but there are simply too many ways to accomplish it. Reducing your variable costs is all about setting plans in motion to improve your work flow, pricing on parts and materials, increasing your productivity, lowering your inventory costs, and a number of other initiatives. So, to make it easy, I’ve included some posts you’ll find on the blog about each of these.  

1. Inventory cost reduction article: Understanding Inventory Carrying Charges: Lower Your Part Costs 
2. Improving work flow & operations: Does Your Company Know How to Identify Bottlenecks in Operations?  
3. Understanding your manufacturing productivity rate: Do You Know How to Determine Your Manufacturing Productivity Rate? 
4. Setting up the perfect work station to improve cycle times: Analyzing Manufacturing Cycle Times When Setting Up a Work Station

 

 

Part of reducing costs involves adopting simple lean manufacturing principles. If you company is a manufacturer, then you can learn more by going here. 

 

When it comes to using best practices in cost reduction, it really boils down to putting aside all the preconceived notions about fixed costs being fixed and unchangeable. Start to think outside the box, and come up with innovative ways to excel in cost reduction. In today's economy, with this recession, it's essential to reduce costs. Unable to do so is paramount to failure.