Overview

Is your business generating profits?

Several business owners can easily tell the difference between the price of their goods or services (revenue) and the cost of obtaining those goods or services (cost of goods sold). Gross profit is the term used in the business world to describe the difference between the two. Because businesses know the cost of their products and add a markup to achieve the sales price, it is rare to discover a circumstance in which a business is operating at a loss in gross terms.

The capacity to keep track of the profitability of products and services is a positive development. Nonetheless, it is equally crucial to understand how lucrative an entire firm is, as many business owners are unaware of their operational expenses.

Numerous businesses fail to turn a profit even though their products are in high demand. This is usually a result of a failure to recognise and appreciate the distinctions between gross profit and net profit.

The following is a quite simple illustration of what is meant:

Gross profit is calculated as sales revenue minus the cost of sales (*gross loss if the cost of sales is higher than sales).

Net profit is calculated as gross profit minus operating expenses. (*If operating expenses are higher than gross profit, there will be a net loss.)

A metric of profitability that easily comes to mind when talking about a company is gross profit (also known as operating profit). This is simply the difference between revenue and the cost of sales. It provides information on how profitable a product or service offering is.

However, it does not provide a complete story. The amount must be adjusted to account for the operating expenses incurred while conducting business. Personnel costs, office rent, and other such expenses fall under this category. This recalculated value is referred to as the net profit or net loss. It is the net profit that tells us how profitable the entire organization is.

Another iteration that is different but comparable is

Business Profit = Revenue – Variable Costs (Costs that vary with sales) -Fixed Costs (expenses that are incurred irrespective of sales).

We shall discuss this in further detail in another article.

Unfortunately, the reality is that many business owners place a high priority on the profitability of their products or services at the expense of the overall profitability of their company.

Many business owners are more concerned with making money than they are with running their businesses, as they would prefer to raise prices and sell in enormous quantities (not necessarily a terrible thing) rather than find ways to lower their costs or reduce the number of supplies they purchase from outside sources in times when profits are reducing.

However, the reality is that no matter how much revenue (or gross profits) they generate, if operating costs are not controlled, the business will “swallow” everything they earn.

Having a net loss for a small business or startup is common in its early years, but this is not an excuse for failing to properly monitor and manage operational expenses to maximise return on investment.

Although it is widely accepted that when it comes to managing a business, the costs must be kept down, doing so is much more difficult than it appears.

Several broad examples of what constitutes operating expenditures include employee costs (including personal taxes and pension payments), rent and rates, communication expenses, consulting fees, depreciation, and repair and maintenance costs, among other things.

The ability to reduce operating costs will put a business one step ahead of the competition. Small business owners should always be on the lookout for ways to lower their operational costs without compromising the quality of their products or making the lives of their staff any more onerous.

Here are a few things to consider when managing operational expenses:

1. Embrace the use of technology to its maximum potential.

It cannot be overstated how important this is. Small businesses that use the appropriate automated procedures have been shown to save more than 50% in operating costs and other resources compared to their counterparts who use manual methods.

The most significant benefit of technology, more so than any other element, is efficiency. This is mostly due to new inventions and the fact that we can employ technology for a much wider range of applications than was previously possible.

A correctly configured automated system can perform more operations with fewer errors than a manual system. Errors and rework have a cost element attached to them that seems invisible. For example, if a customer’s order is messed up, the business will expend money to correct it. It could be in the form of duplicated delivery costs (going to retrieve the item and delivering it again) or losing the sale altogether after spending money to fulfill the original order. No sales and operating costs affect profitability adversely.

For other instances of how technology saves money, consider the following examples:

It would be significantly less expensive to organise and host a meeting using teleconferencing software rather than incurring expenditures for travel, intra-city transportation, and, in some cases, accommodation.

Online purchasing, made possible by technological advancements, saves both money and time. Purchasing office supplies and other products online rather than driving all over the place will save money on petrol and travel expenses, which will translate into more savings!

In the case of labour costs, technology can be used to manage payroll, accounting, communications, and other tasks, allowing a business to avoid spending money on employees who perform menial tasks such as copying documents or manually entering information into a computer program. This is true whether a business is looking for temporary workers or needs someone full-time.

2. Outsourcing

When looking at publicly available financial data, one can see that staff expenditure is usually the most significant operating expense incurred by a company. It would be reasonable to predict that controlling this expense will result in long-term profitability. This explains why, when times are tight, the first thing that is done is to reduce the number of people on the payroll.

It would be detrimental for small organizations, which typically do not have as many financial resources, to acquire and retain employees that drive increasing operational costs. Outsourcing to specialists would be an excellent business decision in this situation.

Outsourcing labour will result in fewer spending increases, allowing the use of capital for other endeavours instead of spending it on staff salaries and other staff-related costs. Typically, outsourced positions are paid on an hourly or project basis, and a business will only be required to pay for services delivered and deliverables; there will be no need to continue paying them after the services have been completed!

However, while the rates for outsourced specialists can be higher, the fact that there are often no employment-related costs associated with them should help keep the overall costs down. It also reduces the need to provide benefits, training, workers’ compensation insurance, or severance packages because these personnel are often hired on a contract basis.

Take the time to shop around for reputable service providers. A business may be able to negotiate good rates.

3. Compliance

Ever heard the expression “compliance is always cheaper”? That is frequently the case. Because of their small size, many small firms and startups believe that the rules do not apply to them. However, this could not be further from the truth, since it is only a matter of time until the authorities catch up with them and slap them with massive fines and penalties. Maintaining compliance with the rules and regulations that govern a company will save money in the long term.

Businesses must file taxes, pay pension deductions, and declare corporate information on an annual basis, to name a few examples of what to do to comply with regulations. This can also apply to contract breaches.

Given that these are unavoidable charges that will undoubtedly affect the costs, do not take any chances with this decision.

4. Office Space

Rent and rates are also typically high on the list of operational expenses that a firm incurs, and for a tiny business, renting a posh office may be a sure-fire way to increase the cost of doing business. Not only can the rent rise quickly, but so can the costs of running the office, such as cleaning, security, utilities, and office supplies, among other things.

In the case of a small business with limited finances, it may be preferable to forego renting an office entirely. Because there are so many firms that provide shared space and collaborative solutions, these costs can be reduced significantly. Also accessible are organisations that allow payment for only what is used, eliminating the need for large upfront payments such as paying all the available capital merely to rent a space.

Telecommuting may also be a viable choice, especially considering the availability of other automated options. You should not fear growing the workforce or expanding the co-working space because there are always ways to do it without breaking the bank.

Furthermore, it provides numerous alternatives for individuals who cannot afford a physical presence but wish to keep their brand and elegantly exhibit themselves.

5. Keep track of expenses.

One of the most important things to do to stay on track with the budget is to continuously monitor expenses. Business owners will be able to anticipate future problems before they occur and discover new ways to manage their organization more efficiently, potentially avoiding overspending.

There are numerous methods for increasing efficiency without incurring additional costs. For example, if internet data expenses are excessive, a business may want to consider switching providers or finding other ways to make the most of a limited data package.

Business owners have no choice but to keep a close watch on operational costs and search for opportunities to enhance efficiency when managing their business to maintain financial stability and survival over time.

Conclusion

In general, organizations wanting to avoid losses and retain profitability must focus on reducing operational expenses as much as possible. A business can become locked in a vicious loop of increasing operating costs. It is vicious because it means that the business is making fewer profits even while revenue is increasing. Once again, the most dependable method of lowering operational expenses is by examining any charges incurred regularly and eliminating those that are not necessary for the company’s operations.

It becomes clear after gaining some essential insights into how small firms might reduce operational expenses that they have a plethora of options at their disposal. The ultimate responsibility for developing and implementing plans to improve operational efficiency and cut expenses rests with the business owners themselves. Hopefully, this post has provided the information and resources needed to put together a plan that will work for your business.

Do you have issues with the tracking, control, and administration of operational costs? Please contact us to see if we may be of assistance.