Saving on costs can be just as Profitable as Selling More

As business owners and managers we often place more focus on selling than on buying, and that’s natural.  You may be surprised though, if you can spend a little time looking at your costs, at how much you can improve your profit.  A small reduction in costs can often achieve a better result on the ‘bottom line than a large increase in sales, and can be a lot easier to achieve in some cases.

There are generally two types of costs in business, being Direct Costs, often termed Cost of Sales or COGS (Cost of Good Sold) and Indirect Overheads.

Cost of Sales/Cost of Goods Sold/Direct Costs

The difference between COGS and Overheads, is COGS mainly only occur when you sell something, whereas Overheads occur whether you make a sale or not.  e.g. Rent is an overhead as this has to be paid whether you make a sale or not, whereas purchase of stock or paying service deliverers only occurs when you sell something. 

The Difference between Cost of Sales and Overheads

The reason it is important to differentiate between COGS and Overheads is because every business needs to know its Gross Profit.  Gross Profit is calculated by subtracting the COGS from the Income figure.  Gross Profit is an important indicator of business performance, both for managers and lenders.  Gross Profit is also an important benchmark against which to measure a business to others in its industry. 

What types of costs are classified as COGS?

• Purchase of stock to sell
• Movement in stock held i.e. what was held at the beginning of an accounting period versus what was held at the end of the period.
• Freight costs to get goods into and out of stock.
• Labour costs relating to production of a service or product.
• Importing costs e.g. duties etc.
• Discounts given
• Stock adjustments/wastage
• Purchase returns and allowances
• Raw materials
• Manufacturing costs
• Packaging

• Other costs to get goods or services ready for sale.

The Key Financial Driver of Business

If you’re in a service business don’t be fooled into thinking that COGS doesn’t relate to you because you don’t sell products.  A factor in COGS for service businesses is ‘Work in Progress’ (WIP). 

Many service businesses have no real methodology for handling Work in Progress or Jobs.  Getting this function under control in your business can have a huge impact on profit and cashflow. 

We once asked an electrical contractor how often he did his invoicing to customers and the answer -

“When I run out of money!”

It is not very difficult to put in place a process for ensuring jobs get invoiced out as quickly as possible, therefore speeding up payment and reducing cashflow squeeze.  CAD partners can show systems that easily speed up WIP and jobs, and the resulting improvement in profit and cashflow far outweighs the cost.

Budgeting for COGS is an important function in monitoring profitability.  COGS can very easily ‘creep up’ without you realizing it, especially in the current climate of high oil prices.  These increased costs need to be passed onto customers in order to maintain margins.  Keeping track of such costs may seem like a pain but the resulting control over margins and profitability far outweighs the cost of maintaining such control.

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