Cost analysis is crucial for steering a company toward greater profitability. You don’t need to hire an accountant to do it, because it’s genuinely simple, and today we’ll try to explain it in language anyone can follow, without too much financial jargon.
How do you analyze your costs?
Without going too deep into accounting, a company’s profit is basically sales minus expenses. Expenses include both fixed and variable costs.
1. Fixed costs
- Staff salaries
- Staff insurance
- Business insurance
- Administrative services (accounting and advisory fees)
- Rent or mortgage on the business premises
Keep in mind that any fixed cost can become variable for a period of time, when an increase in production makes it necessary to create new jobs or expand facilities.
In short, a company’s or business’s fixed costs are the ones that don’t change whether you sell more or less. They’re always the same, which makes them the easiest to analyze and examine when you’re looking for things to cut or eliminate to become more profitable.
2. Variable costs
- Raw materials (more raw material needed for production)
- Energy (more production means more energy consumed)
- Subcontracting costs
- More staff or more paid overtime for workers
By variable costs we mean the ones that grow with an increase in demand or production.
Variable costs are very dangerous. I’ve known companies that made less profit the more they sold. They increased production but their profitability went down.
When a business grows or faces excessive demand, it should draw up a new business plan to deal with that surge, because with a temporary rise in demand you can end up showing losses instead of profits at the end of the quarter or the year.
If you look carefully at what your fixed costs are, which we commonly call expenses, and at whether you’re currently facing any kind of variable cost, a simple analysis will let you study and rethink your company’s approach and take the measures needed to increase its profitability.
Believe it or not, many fairly large companies allow themselves the luxury of not putting their accounting and finance department to work on this simple analysis, because they can pay their suppliers without any trouble. It’s only when they notice something is wrong and their first promissory note or check bounces that they desperately try to find the cause. And the answer, as we’ve discussed before, doesn’t lie in solving problems that have grown worse through neglect, but in anticipating a future problem and inoculating against it quickly.
Further reading
- How to run a small business in times of crisis
- Why new businesses fail
- The advantages of starting a business in times of crisis
- 5 ways to grow your business
Featured image: Jacob Edward, CC BY 2.0, via Flickr.
