Examining expenses is essential exercise for small business owners

Just about every business wants to improve profits and do it quickly. There are three methods of accomplishing this: increasing revenue, reducing costs, and increasing revenues while reducing costs.

Of the three methods, reducing costs is the easiest and most effective, as every dollar saved hits the bottom line. When increasing revenue, however, only a small percentage of that increase hits the bottom line because there are costs associated with revenue.

Imagine, for example, I have sales of $1 million with a 10 percent net income margin (net income divided by sales). If I reduce my costs by $100,000, my profit increases by $100,000. If I increase sales by $100,000, only 10 percent of that, or $10,000, hits my bottom line. If I do both, my profits increase by $110,000.

I believe almost every business can easily shave 10 to 15 percent of its costs by looking at each individually and seeing if it can be reduced by rebidding or renegotiating with suppliers. Too often, firms keep buying from the same supplier because they develop a trustworthy relationship. However, management cannot allow this to get in the way of operating a business with better cost controls.

I was working with a firm that had not re-evaluated its insurance costs in more than 10 years. After contacting the existing insurance agent, the firm was able to reduce the cost by more than $10,000. But after shopping with other insurance agents, the firm got the cost down by more than $20,000 with the same coverage.

The point: While relationships are important, the success of your business is even more important.

Labor costs are another area where businesses can find expense reductions. Firms have an obligation to ensure the business is sustainable, which means carefully watching labor costs.

So how do you know if labor costs are too much? One way is to compare staff salaries to those of similar companies to see if caps need to be put on positions.

Businesses often continue to reward their loyal workers with salary increases every year, and this can get out of hand quickly. One firm I was working with was paying an office manager $150,000 a year because she had been there so long, and they considered her part of the family.

After doing further research, they found that the maximum fair salary for that position is around $75,000. Going forward, that firm established salary caps for all positions.

A second way to evaluate overall labor expense is revenue per employee. If the revenue per employee is $130,000, and the industry average is $200,000, investigate why one is lower and see if reducing some of the labor costs can bring it up.

Look at all expenses each year to find ways to reduce costs and raise profits. This is an easy exercise that produces numerous rewards.

This story was originally published March 23, 2017 at 12:21 PM with the headline "Examining expenses is essential exercise for small business owners."