Spend Management
How can a business reduce fixed costs?

How can a business reduce fixed costs?

illustrated hand holding a device with a dollar signHeader imageHeader imageHeader imageHeader image

The success of a business rests on its ability to adjust and adapt to improve earnings. The current economic climate has tested businesses of every kind, forcing business owners to find creative solutions to the problems of staffing, decreased revenue, remote work, and more. When increasing revenue isn’t possible, you can still improve profit margins and cash flow by reducing cost.

What are fixed costs?

Fixed costs are the regular, expected expenses each month to keep your business running. Fixed costs are predictable and usually set to the same total each month. However, just because they’re fixed doesn’t mean they are permanent. You likely have some areas of high fixed costs. These costs can be adjusted, negotiated, or even eliminated if a reduction in business expenses is necessary.

Examples of fixed costs

  • Rent or mortgage
  • Labor cost
  • Insurance
  • Property taxes
  • Interest
  • Advertising
  • Standing orders
  • License or membership fees

Other types of cost:

  • Direct costs: tied to a specific cost object, such as materials or labor
  • Indirect costs: incurred in the creation of your good or service, like insurance
  • Variable costs: changing fees or bills, such as office supplies
  • Operating costs: required to run your business, such as electricity bills
  • Opportunity costs: what you are giving up or losing by choosing a course of action, such as hiring fewer workers but being able to pay them more
  • Sunk costs: costs that cannot be recovered or undone, like rent

How to analyze cost

Once you realize the need to adjust your monthly costs, the first step is to really analyze each cost in your budget and where you have seen “creep” in overall total or unnecessary expenditures.

Total fixed cost

Determine your total fixed cost by adding up each recurring, expected expense for the month. Check bank statements, credit card statements, invoices, and any other expense report records to itemize each expense, and then separate variable expenses (changing, unpredictable) from fixed.

Average fixed cost

For long-term budgeting purposes, average fixed cost might be a good indicator. Calculating your total fixed cost for each month and then averaging for a season, quarter, or year can help your finance team notice trends or problems with cash flow.

Review quantity

Note the quantity or selection of each fixed cost item. Do you need that exact quantity? Could you save by ordering a greater quantity with less frequency?

Examine pricing

Fixed cost “creep” is common for small businesses. This happens when the price of a fixed cost slowly increases over time. It could come in the form of small upgrades or additional shipping fees, or it could just be an increase in the price schedule due to inflation or demand. Carefully monitor the price of your fixed costs over time.

Determine the source

Along with each price, take inventory of your vendors and their locations. How much do they charge for things like packaging, shipping, delivery, etc.? Do you have a pre-negotiated contract? When looking to cut fixed costs, sourcing will be a key part of your strategy, so be thorough.

Note usage and cut waste

Unfortunately every company deals with waste. Assess how you are using or wasting each of  your line items, such as inventory or office supplies. For each purchase or cost ask yourself “Knowing what I know right now about the price, delivery, quality, and usage of this product or service, would I buy again?” If the answer is no, you can flag these for extra scrutiny.

Strategies for reducing fixed costs

When it comes time to make the cuts that affect your fixed costs, it’s important to move strategically. Instead of slashing your budget indiscriminately, consider where the following strategies can have the greatest impact in your business.

Reducing labor costs

Payroll is a significant portion of your fixed cost, and if you’re in danger of insolvency it might be an unavoidable target of budget cuts. There are a few ways to do this:

  • Hire entry level employees or interns
  • Cut salaries
  • Choose a 4 day workweek
  • Layoffs

When you’re facing a financial crisis, it’s easy to see layoffs as a quick cost reduction to a hefty line item in your business budget. However, getting rid of people in this way impacts more than just the people collecting their severance checks. Layoffs can also increase “survivor” stress levels, decrease morale and satisfaction, and even cause mistrust among your employee base.  Of course, this isn’t always the case. The current pandemic has brought to light several companies that have handled layoffs with grace, generosity, and respect. But layoffs should still be considered a last resort.

To determine if layoffs are necessary, assess your monthly payroll costs and recurring revenue. Work out the details clearly and craft a transparent, cohesive, compassionate message. Be as generous as possible with severance packages and offer outplacement or support where possible.

Reducing rent or mortgage

Rent or mortgage payments are significant overhead for your business, and may not even be necessary. Check your lease for clauses that can release you from the contract, or see if you can negotiate a more favorable rent payment with your landlord. Look for space in a more affordable area, or consider subleasing parts of your underused office space.

With COVID-19 restrictions in place, many companies have transitioned to a fully remote workforce. While the switch to full-time WFH had some hiccups at the beginning, nearly 43% of full-time employees want to continue to work remotely even after the economy has reopened.

Making it easy for employees to work remotely has tons of cost-saving benefits, especially to your overhead. If you haven’t already taken the time to get employees set up with remote workspaces that optimize efficiency, it could be worth your future investment.

Reducing insurance, fees, and vendor purchases

From vendors to office spaces, you should always be aware of the market rates. Fixed cost “creep” can also mean that your vendor prices stay the same, but the market rates for those goods have dropped. You can effectively reduce fixed costs just by making a few phone calls. Insurance is a good example of this: get quotes from multiple insurance providers and make a switch to save more money each month.

Another critical area to inspect is your subscription services. Many paid SaaS subscriptions can be charging you monthly for services you don’t use. Look for free alternatives to paid subscriptions or options for consolidating multiple services into one platform.

Reducing through refinancing

Small businesses often start out on a shoestring budget, or the credit of their owners. The initial loans and debts of your businesses could be eating away at your bottom line with interest and principal payments you can’t manage. Refinancing a mortgage or loan can significantly reduce monthly payments and the interest you pay over time. You can also consider debt consolidation if you are making payments on multiple debts each month.

The information provided on this page does not, and is not intended to constitute legal or financial advice and is for general informational purposes only. The content is provided "as-is"; no representations are made that the content is error free.