Reduce Costs | 9 mins read

Identifying When and How to Cut Costs

identifying when and how to cut costs
Lauren Christiansen

By Lauren Christiansen

Large and small businesses across the United States have to maintain a level of growth and stability in order to survive. When companies are not saving money, and overspend on advertising, operating costs, and other various business expenses, it can prevent them from achieving financial gain and expanding their brand.

Determining which of these factors is absolutely worth monetarily maintaining in order to reduce costs can be a challenge. Fortunately, there are solutions that can help in determining where a company can afford to reduce costs.

By deciphering which aspects of the business are too expensive, various approaches to reduce costs and cut back on unnecessary spending can be executed. In doing so, the business can stand out amongst competitors and increase overall profits.

Identifying the Problem

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Running a business can be an expensive endeavor. Owners have to consider labor costs, cash flow, manufacturing expenses, office rentals/workspaces, supplies, and whether the gross revenue exceeds their business expenses. External factors such as the state of the economy, demographic changes, and the market value of certain products can also impact a business. If the price of doing business exceeds the revenue, then the owner will probably need to cut costs and make some difficult decisions. Some indications that a business needs to cut expenses include-

  • Fewer customers
  • Uncertain economic conditions (i.e. recession/depression)
  • Increase in rent/mortgage
  • Too many employees
  • Increase in minimum wage requirements
  • Low annual revenue
  • Overpayment (manufacturing, supplies, equipment, etc.)
If the business doesn't find a long-term, effective way to reduce overhead costs, it can be difficult to continue operating. Fortunately, there are several ways for owners to allocate their money properly, cut back on unnecessary expenses, and go back to operating within a conservative budget. Businesses shouldn't just reduce costs in order to survive and maintain their daily business operations. There are many other benefits to cost-cutting, such as-
  • Reducing the likelihood of future financial hardship
  • More money to expand and invest in new products
  • Increased wages and happier employees
  • Increased profit margin by lowering overhead costs
  • Ability to provide lower prices than the competition
The owner first needs to figure out which business costs are too expensive, and then figure out ways to resolve them. For example, if the office rent has become burdensome, the owner should consider moving to a more reasonably priced location. Regardless of which metric the owner decides to cut, the goal should always be maintaining the stability of the operation so the company can continue to grow.

Overview into Operating Costs

The day-to-day maintenance costs that come with running a business are referred to as operating costs or operational expenses. One of the foremost components of operating costs is the direct costs attributed to producing a company's goods and services, or COGs. Other operating expenses include-

  • Labor costs
  • Employee health insurance and pensions
  • Sales commissions
  • Maintenance costs
  • Spreading payments over multiple periods of time
  • Operating equipment decreasing in value over time
Managing operating costs effectively can contribute to a company's bottom line because it frees up more funds for investment and growth. If a company spends too much money on any of the operating cost metrics, they will lose money over time. Other factors to consider-

Operating Income
The total profit associated with a company's operations. This is calculated by the following formula-

Operating Income = Total Revenue - Operating Expenses

For example, if a business earned a total of $500,000 per year in revenue and their operating expenses were $80,000, the total operating expenses would equate to $420,000.

Operating Ratio
This ratio compares the operating expenses to the income, which allows companies to track their efficiency. Good operating incomes can be relative to the size of the business and how long the company has been around. However, operating ratios indicate financial health by measuring efficiency as a percentage.

Operating Expense Ratio = Operating Costs / Revenues
So, if a company earned $400,000 in revenue, and their operating costs were $100,000, their operating expense ratio would be .25 or 25%. This is a fairly good operating cost to expense ratio.

Top Ways to Cut Operating Costs

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Small and large businesses should always find ways to cut their operating expenses and reduce costs without sacrificing the quality of their service and hurting their staff. In doing so, businesses won't fall behind the competition or lose their capacity to innovate and grow. Some best practices to reduce costs are-

1. Outsourcing
Outsourcing certain business practices to third party specialists can be a great way to increase efficiency and reduce costs. For example, advertising and marketing can be expensive for small businesses, though they know it's necessary to achieve name recognition. Also, some labor can be outsourced to foreign countries, but this can sometimes affect the quality of customer service because outsourced labor doesn't always know the ins and outs of a particular business. Though hiring an outside vendor might seem expensive, delegating tasks is an investment that can save owners time and money.

2. Look for Better Rates
If the business has been utilizing the same vendor for years, they may not know that there are much cheaper vendors available. Owners should start looking online and comparing prices in order to see if certain aspects of their operating costs can be cut by utilizing a new vendor. Of course, lower costing vendors may deliver a lower quality of service so owners should make sure they do the proper research before picking one.

3. Telecommute
Computers have provided a way for many employees to do their work from home. If companies are spending an excessive amount of money on rent or real estate, they should consider allowing team members to work outside of the office. Even if a portion of members works from home, the remaining in-house team members will be able to fit in a smaller office space, reducing the cost of rent in most cases.

4. Cancel Unused Services
Business owners should go through all of their expenses and figure out which services or vendors they no longer use. If some haven't been utilized in a few years, then the owner should either look for a cheaper plan or cancel the service altogether. Many services are set up on auto-pay, which can be easy to lose track of or forget about. This can be remedied by going through each expense line by line to determine how high certain services are and what can be cut to reduce costs.

5. Pay Invoices & Credit Card Charge Early
Some companies provide a discount if invoices are paid early or on-time. Businesses should take advantage of any available discounts and check to see if their vendors offer special deals. This can help cut back on business credit card expenses.

7 Tips to Reduce Costs

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Cutting down on operating costs is only one part of the equation. There are several other ways for businesses to reduce business costs and get back within a reasonable budget. Other recommendations to consider are-

1. Don't Over-Hire
Hiring freelancers or independent contractors can be an effective way to cut business costs because they work on an hourly or per-project basis. Full-time employees require salaries, health insurance, paid vacations, and office space. At the same time, businesses should only hire freelancers when salaried employees are incapable of taking on new tasks. If some of the freelance work can be done by salaried employees, it might be beneficial to simply increase the full-time employees' pay rather than hire another outside source that costs money.

2. Cut Back on Business Travel
Sales professionals and corporate team members are frequently required to travel for business. However, some sales employees make trips once or twice a month, which can add up over time. If employees are registering for every possible conference or network outside of a region, there needs to be a return on investment for those travel expenses.

If members of the sales team are traveling more than they are acquiring new clients, the owner should tell the employee to find contacts within his/her own region. Sales employees and corporate members who generate a return on investment by their travel can continue as usual, providing they still continue to generate revenue for the company.

3. Buy Office Supplies in Bulk
It may seem inconsequential to take occasional trips to a local convenience store for supplies, but it can add up over time. Purchasing supplies in bulk from larger office supply retailers is a great way to promote cost-saving and reduce frivolous spending. Small businesses with less than ten employees may not feel it's necessary to purchase in bulk, but multiple trips can grow to be very costly. Research vendors in the area and shop around for the best available pricing.

4. Eliminate Unnecessary Perks
Small businesses may think that in order to compete with larger businesses, they have to offer more perks to employees, such as free food, event tickets, gym membership subsidies, or paid birthdays off. While it is a good idea to create a positive work environment for staff, its better to provide comprehensive benefits and vacations. Those who work for a small business usually understand that the same perks offered at large corporations are not possible within this workplace. Eliminating excessive perks while still offering benefits is a way to reduce costs while still keeping employees happy.

5. Embrace Technology
Modern technology has provided several different online systems and software programs that can optimize business operations and streamline day-to-day tasks. Some of these include dashboards, or user interfaces that house different data sources so owners can generate insight into key performance metrics within the company. For example, a dashboard can allow owners to compare their operating costs from last year to the ones this year and then figure out which factors contributed to an increase in costs.

Other modern AI technology can work faster than humans and don't require salaries and paid vacations. Utilizing technology is a great way to increase the efficiency of day-to-day operations while simultaneously decreasing labor costs.

6. Streamline Marketing and Advertising
Businesses should calculate how much they spend on advertisements, public relations, social media marketing, search engine optimization, direct mail, and trade show appearances. They should then see which of these metrics doesn't produce a high turn-on investment and replace it with a less expensive form of marketing.

For example, many SEO (search engine optimization) companies charge high rates and over-promise on their ranking capabilities. Businesses can actually perform much of their own search engine optimization by doing research online. Employees within the content or marketing team can also do much of their own social media marketing or company blog writing.

7. Be Energy-Efficient and Reduce Paper Waste
Utility costs can be quite expensive, and there's many ways to incorporate energy efficient, greener methods of operating a business. Simply turning off lights when not in use and making sure employees shut off their computers at the end of the workday can save quite a bit on utilities. Businesses should shut down any operating machinery or appliances at night that aren't required for safety and storage.

Cutting back on paper waste can also be a simple, but smart way to minimize office expenses. Some tips include printing and copying double-sided on default, utilizing file exchange services that don't require traditional courier services, reusing paper whenever possible, and tightening margins and shrink fonts on reports. The utilization of dashboards can also cut back on paper usage because reports can be delivered through email.