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How to improve your profits by reviewing your cost base

By Riina Trkulja

Now more than ever, businesses are looking at their cost base but it should not just be practice during crisis, it should be business as usual. Here are six tips how you can improve your profits by changing few things in the way you run your business. Care should be taken to avoid false economy by cutting out necessary cost that would improve productivity.

 
1) Aim to achieve “good” gross profit margins in your industry
If you are looking to reduce cost base, good starting point would be to analyse expenditures in management accounts as a % of revenue. You will need to look at each cost in your business rather than just focus on the biggest items, as small cuts can often add up to big savings.
Most businesses will have variable and fixed costs. Variable costs change in line with your output or sales so if your sales decrease these costs should also decrease and vice a versa. Each industry is different, but most commonly your variable cost should be 30-50% of your revenue (calculated as cost/revenue*100), giving you 50-70% gross profit margin. If that is not the case, try to increase your prices perhaps by selling add on services or bundling up your products in a way that improves your margins or alternatively look ways to cut cost which we will discuss below.
 
 
2) Negotiate with your suppliers 
If you have historically been paying higher prices it doesn’t mean that you need to continue with these prices in the middle of a crisis. Read your contract first and understand your termination clause. In addition, see what the alternatives are. Your supplier wants to continue in the business too and they might just work with you to get through this crisis together. 
If you are negotiating new contracts, try to have option to terminate at 30 days’ notice, if there are price gains to be had, then perhaps a maximum term should be a year. That also goes for rent, where break clauses are common. It gives you the flexibility to change suppliers if necessary.
Watch out for additional charges which may be more expensively priced than average market value just because of convenience.
 
 
3) Understand the true cost of hiring someone and consider alternatives
Good people can make or break your business but there are some skills you can outsource, hire part-time or get apprentices for.
When hiring someone, people often forget to consider the full cost of having an employee. On top of gross salary there is employers national insurance of 13.8% and employers pension of 3%. For example, on £30,000 gross annual salary, the additional cost to the employer would be £3,641 by way of employers NI and compulsory pension contributions. In addition, there is cost of providing the office space, IT equipment, training, drinks, and entertainment if you decide to take them out. You must also stay up to date with employment law and consider how you motivate and manage people.
 
It might be cheaper and easier to outsource certain services like accounting, bookkeeping, HR services and marketing. There are many virtual assistants and even virtual Finance Directors that provide their services by the hour or on a day rate offering you the flexibility that small businesses so often need.
 
If you have the capacity to train then having a bright and enthusiastic apprentice might work out better than someone more experienced but undermotivated. The minimum hourly rate for apprentices is £4.15 vs living wage of £8.72 for 25 year olds and over. National minimum wage is £8.20 for people under 25 years of age.
 
 
4) Are your processes and line of communications simple and clear?
Inefficient processes can be one of the biggest costs to the business but they are often hard to identify and quantify. Once that is done, the solution becomes pretty clear. If you have defined the process, it is important to communicate it to your colleagues so they know what is expected of them. 
 
Most common causes of delays and wasted resources would be poor system integration and manual data entry, staff idle time, poor communication, lack of good data and relevant market analysis resulting in slow adjustment to changing demands, not enough clarity in job roles and responsibilities, no clear purchase order process where there are limits and authorisations in place before cost is incurred.
 
Each business is different and has different challenges. Start by mapping out your production or work processes and see if there is anywhere you can make it more efficient. 
 
 
5) Produce management accounts and budgets regularly, it gives you valuable insight
In your management accounts include your variable costs and profit as a % of sales and monitor absolute value as well as % in addition to other key performance indicators. This way you know what you are spending and which products have lower margins. 
 
Budgeting will help you plan ahead and anticipate resources needed to run your business and achieve your goals successfully. As you understand your purchasing needs, you will be in a better position to negotiate with your suppliers and buy in bulk if necessary. Do not worry about trying to create budgets that are 100% accurate.
 
 
6) Be creative with your costs 
If current crisis has thought us anything, it is how much can be done by using the Internet and staying at home. There are some businesses that will need face to face interaction, but there are many that can use working from home if not full, then part of the time, which should reduce their rent and office costs.
 
Advertising and marketing is where creativity will really pay dividends. In ideal world you would look to get 5x return on your marketing spend and that would include the cost of marketing personnel. It is unlikely to be the case now but if you focus on marketing and PR channels where your clients spend most of their time, you may discover some avenues that are cheaper and give you better return on investment. 
 
Stay well and safe!
 
Riina Trkulja
 
Riina is ACA qualified chartered accountant, she worked for James Caan, PwC, KPMG and BT serving big and small businesses across the UK.
She supports small businesses by providing finance team outsourcing, bookkeeping, accounting and Virtual Finance Director services at reasonable rates. By working closely with her clients she has improved their cash flow, identified cost savings, helped with debt collection and mentored how to gain powerful insights by using financial information. 
If you need any help with the issues identified above, feel free to get in touch on hello@accountsassistants.co.uk