All of us are aware of the very basics of a business. You have to make money, you have to spend money and when all of that is taken together, you want money left over. Sometimes that doesn’t go as planned.
So what does a Business owner do? If you are like many, you start to cut costs. You cut out the things you spend money on in hopes that when you subtract your expenses from your income, that you either have just enough or some left over.
This is how the majority of us manage our households and more specifically, our household budgets. We look at what we make, we cut out things we see as luxuries or those that are not necessary and everything turns out alright. Unfortunately, this practice is not conducive to a successful or sustainable business. We cannot cut costs or improve efficiencies to make our business more profitable. Profit in business is exactly what the focus is.
Some are familiar with the old adage, “You have to spend money to make money.” In a business that is as valid as the noted economist Milton Friedman’s saying that the main purpose of a business is to maximize profits for its owners.
Cutting expenses are important. However, cutting the wrong expenses or looking at your business as if it were your household, is not a sound strategy.
Yes, this means we are going to have to talk about numbers and numbers mean math. So go ahead, scream, shake your head…but then let us get into just how simple this math is; and we won’t use algebra.
One of the most common expenses a business will cut when revenue or profits are down is marketing or advertising. This is when you need these dollars the most, they are an investment in your future and should be treated as such. That doesn’t mean simply spending dollars for advertising. It means spending your dollars where they will do you the most good, where you will get the greatest return on that investment. Advertising with a very specific eye on the return instead of the simple fact you are advertising or advertising in a “cool way”, is how this becomes a true investment instead of a cost.
Return on investment. A term often misunderstood but in reality is very simple. It is simply the amount of money you make because you spent money. It is commonly referenced by a percentage. Using our advertising example above, if you spend $500 on advertising and it gets you $2500 in new sales, you have a 400% return on your investment ( total new sales – investment divided by investment multiplied by 100 – or ($2500-$500)/500 = 4 x100=400 or 400%). The catch here is that the gain isn’t spent on things you don’t need.
Another potential poor choice in determining a reduction in costs versus investment is equipment. For example, you have equipment you use to provide your product or services. It is old, tired but it still works. New equipment is available that will double your output in half the time. This is an investment, a spending of money, that could make your business more efficient, save money and because you invested in this new equipment make you more money in less time. You can use the same formula we used for advertising to look at how well this will help your business.
Businesses trying to save money will cut their payroll costs too. I confess that this is sometimes necessary. Good prior planning or managing of the current situation makes this a different effort with different outcomes. There are always the intangibles of a payroll reduction. Animosity by former employees, bad press in the local media, and all of the other emotions that naturally happen when people lose their jobs. It doesn’t have to be done that way.
Consider a mixture of a base salary and some form of performance pay or profit sharing. If you want employees to help you get out of a bad situation, incentivize them to help you. Give them more than a thank you. If you pay a decent wage but offer incentives based upon sales, production, efficiency or anything you can measure that adds value to your business and your employees can provide solutions to is a good area to look at. There are good ways and not so good ways to structure these. How you do that is driven as much by your business and industry as it is the culture of your individual business. Regardless, pay cuts and people cuts are not always a good solution.
There are many other examples we could use. The bottom line is your businesses bottom line. Investing versus cutting – which will you choose?
Want to know more? Ask me, I’m here to help.