What are your costs?

As business owners 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.

Understanding your Costs

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

Cost of Goods Sold or Direct Costs

COGS are sometimes referred to as COS or Cost of Sales.  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 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

Cost of Goods Sold is often the most sensitive Key Financial Driver in relation to results.  We can show an example where a 1% reduction in COGS can add $23,000 onto profit and $32,000 cash back into the bank. This is a healthy result for a small amount of work.

Service Businesses Beware

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. 

Work in Progress & Jobs Management

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 can show examples where a one day reduction in the average WIP days can put $7,000 back into the bank account. 

We recently spoke to an electrical contractor who said he did his invoicing to customers “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.

Monitoring Cost of Goods Sold

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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