Creating an effective expense control program

With today's slowing economy many business owners are searching for ways to maintain profitability. A well-defined cost reduction program can yield positive results, but requires a well-planned approach. Unless adequate records are maintained through a proper accounting system, analyzing your costs can prove difficult if not impossible. Thus, an understanding of how expenses inter-relate with revenues, gross profits, costs of goods sold, and inventories is essential to effective cost reduction.

This means that cost reduction should go beyond just the reduction of specific expenses. Admittedly, simply reducing your expense dollars can produce greater profits but a well planned cost reduction program may require a complete overhaul of your internal methods and procedures.

One example of this is more effective use of your merchandise display space. The resulting increased sales volume per square foot can produce a larger return for your advertising and sales promotion dollars. Shown below are some tips that can help you reduce costs and improve your management procedures.

Big sales don't always spell big profits

You should be aware that steadily increasing sales can create the mistaken appearance of prosperity, while out-of-control expenses are eating up your profits. Determining what expenses you pay goes far beyond simply knowing what your costs are. For example, consider your payroll expenses. Your sales clerk's productivity is the real key to reducing your payroll costs. Consequently, if you train your sales clerks to make more sales, but at higher unit prices, you increase their productivity and your profits without increasing your payroll expenses.

Analyze your expense percentages

When you review your expenses, you should use percentages rather than actual dollar amounts. If you increase sales but keep the dollar amount of your expenses the same, your expenses as a percentage of sales decrease. This means that, with a decreased cost percentage, your percentage of profit goes up. Conversely, if your sales volume remains level, you can still increase your percentage of profit by reducing specific expense items. Ideally, your goal should be to do both: to reduce specific expense items and to concurrently increase their productive worth.

Accounting information is essential

But before you start cutting your expenses, you should determine whether reducing costs actually will increase your profits. This requires having detailed information about your company operations, available only if you have an adequate record keeping system. These records provide the data needed to prepare a profit and loss statement, a budget, break-even analysis, and comparative evaluations of your operating ratios with those of similar types of businesses.

Break-even analysis.

Break-even is the point at which gross profit equals expenses. To put it another way, it's when your sales volume is sufficient to start showing a profit. Once your sales volume reaches the break-even point, your fixed expenses are covered. Happily, beyond the break-even point, every dollar of sales should earn you an equivalent additional profit percentage. And once your sales volume passes the break-even point, your fixed expenses percentage should decrease as your sales volume increases. Because break-even is such an important resource, there is simply no excuse not to have it available as a vital analytical tool.

Profit and loss statement

Your profit and loss statement provides periodic summarized expense information and this is where you will rind expense items that bear watching. Ideally you should prepare two periodic P and L statements, one to report the sales, expenses, profits and/or loss of your operations cumulatively for the current business year-to-date, the other to report on the same items for the last complete month or quarter.

Both statements should also include the following: This year's figures and each item as a percentage of sales, last year's figures and the percentages, the difference between last year and this year over or under, budgeted figures and their respective percentages, the difference between this year and the budgeted figures over and under, average percentages for your line of business (industry operating ratio) if available, and the difference between your annual percentages and the industry ratios - under or over.

Locate and flag expense variations

Armed with this comparative information, you can identify and flag expense variations in three ways: (1) by comparing this year to last year, (2) by comparing expenses to your own budgeted figures, and (3) by comparing your percentages to the operating ratios for your line of business. Just keep in mind that the most important basis for comparison is the percentage figure. It represents a common denominator for all three methods. Once you have identified and flagged the specified percentage variations, you should then study the dollar amounts to determine what action is needed.

Time for timely action

After identifying problem expense items, your obvious next step is to reduce those identified problem costs to increase your profit. Here, the key to effective cost-cutting action is determining the worth of the various expenditures. Once you've established the worth of these costs, you can then make rational improvements in expenses. This requires an open eye and an open mind.

Finally, remember that its better to do a spot cost analysis once a month than to wait several months and then do a detailed study. So take action as soon as possible and refine your cost-cutting action as you go along rather than waiting until things get out of control.

Robert E. Bunn is an acquisition and management consultant in Cape Girardeau. (573-333-3351 or email at rbunn@igateway.net)