Adaptability has been a hallmark of businesses surviving in the current economic climate, and we know many business owners are looking for ways to increase profits and decrease expenses.
While you may not have much control over increasing your sales, you can still increase your profitability by significantly cutting your operational cost. As you grow, your operating expenses will too, meaning that you’re losing a larger chunk of hard-earned revenue. Cutting down your operating costs can maximize your profit margins, help stay on top of current expenses, and keep you succeeding even in uncertain markets.
What is operating cost?
Simply put, operating cost is the sum of all of the things you pay for to run your business. Owning and running a business is expensive, and the operating cost must be a small fraction of the incoming revenue in order for a business to succeed. What do you need to keep your business operating? These are your operating costs and include things like payroll, inventory, insurance, bills, and more. You can calculate this number by adding your operating expenses to your cost of goods sold (COGS).
Operating costs = operating expenses + COGS
What are operating expenses?
Operating expenses, sometimes referred to as OPEX, are the maintenance and administrative costs of running the business on a day-to-day basis. These are the “extra” costs that aren’t directly associated with your product or service, but are necessary expenses for operation.
Examples of operating expenses include:
- Payroll for staff
- Insurance
- License fees
- Rent
- Research
- Marketing (including for social channels like Facebook)
- Accounting fees
- Building maintenance and repairs
- Office expenses
- Utilities
- Attorney fees
- Property taxes on real estate
- Vehicle expenses
- Travel expenses
- Overhead costs
Cost of goods sold
Cost of goods sold (COGS) includes everything you pay for to produce your product or service. This could be paying for materials, manufacturing, labor, packaging, storage, equipment, or any other element necessary to create and sell your product.
One helpful statistic for your business is operating income. Operating income is a calculation showing how much you are actually bringing in after covering your operating costs. Operating income is merely a number and will vary widely from business to business, but it can be a good indicator of growth or loss over a period of time.
Operating income = Total revenue – operating cost
Operating expense ratio
A more helpful statistic, one that might be reported to your board or potential investors, is your operating expense ratio. The operating expense ratio is a good indicator of financial health, and can help you see where you rank within your industry. The lower the ratio, the more efficient your business.
Operating expense ratio = Operating cost/revenue
8 ways to reduce operating costs and expenses
While many business owners focus on increasing their sales and maximizing revenue in order to increase their profit ratios, small business owners may find greater success in reducing their operating costs. After calculating your operating costs and operating expense ratio, you may realize that your operating expenses aren’t at healthy levels.
Cost reduction is possible and effective. All small business owners should critically assess their operating expenses and find ways to cut costs without sacrificing quality or overburdening their human resources. We’re sharing a variety of tips for cutting your operating costs to find better financial success in the short and long term.
1. Normalize remote work
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. You may also consider the opportunity to sell or lease unused office space as a way to mitigate cost.
2. Save money on insurance
If you’re looking to lower your financial expenditures, it might be time to reevaluate your benefits package for some cost savings. You still want to make sure your insurance offerings are competitive, but find ways to cut costs if you can.
Looks for bundled deals, where multiple offerings (like dental and vision) are covered under one policy. Shop around with different insurance brokers to make sure you’re getting the best rates for your unique business needs; remember, brokers can receive commissions from insurance sales, so they may not all be incentivized to save you money.
3. Consider a four-day workweek
While the mental benefits of a four-day workweek are becoming more widely accepted, there are also significant cost benefits associated with fewer working hours.
Shifting to a four-day week automatically eliminates 20% of variable overhead expenses—saving thousands annually on electricity, office supplies and even cleaning. This can also reduce the need for fringe benefits like office food, snacks, and even commuter costs.
Plus, companies like Microsoft have announced that switching to a four-day workweek led to a 40% boost in productivity. Between reduced overhead and happier employees, a shorter workweek could be well worth your consideration.
4. Work smarter with technology
Embracing technology can be awkward at first, and even include some upfront cost, but in the long run it can reduce your costs. Online systems and software can improve efficiency and free up time for employees at all levels of your business. Introducing forms of artificial intelligence (AI) can process data faster and minimize human error. Technology can also improve communication within your organization and along the entire business supply chain.
BILL Spend & Expense is a great example of technology cutting costs. It can eliminate costs associated with data entry, paper invoices, reimbursements, and company spend tracking. In fact, BILL Spend & Expense can help you significantly control your company spend for decreased operating costs.
5. Outsource when necessary
As a business owner you may be spread pretty thin. This can be especially true for new businesses, which must maximize the effectiveness of all employees to avoid startup overspending. It can be tempting to try to wear all of the various hats yourself, or to overburden your staff, but you may uncover hours and hours of work being wasted trying to cover specialized tasks with amateur experience.
Delegating or contracting out work to professionals may actually significantly reduce your operating costs while increasing your revenue. Outsourcing to professionals for advertising, marketing, financial advice, legal matters, and other distinct areas can provide much more efficient results and free up working hours to dedicate to meaningful progress. You may also find that paying a full time accountant or legal counsel isn’t necessary, and you can cut costs by outsourcing that work for fewer hours. While not always the right answer, it can be something to consider.
6. Negotiate & shop around
Far too many business owners realize too late that they’ve been overpaying for goods or services for years. A smart and instant option for cutting your operating costs is to reduce what you’re paying for goods and services. You could set up a workflow that includes getting bids from different vendors for each project. You may be able to negotiate lower prices for loyalty or exclusivity, or for buying in bulk or cooperative buying with other small businesses. Get creative and don’t be afraid to search for newer, more affordable alternatives.
7. Pay smart
Of course you know that late payments are expensive and problematic. Making late payments on invoices or lenders can adversely impact your business credit in addition to incurring expensive fees. Set up automatic payments to avoid this, and investigate whether early payments can save you money. Often discounts up to 5% are given for early payment on invoices, and extra or early payments on loans and debt can decrease the amount you’ll pay in interest over time.
8. Identify inefficiencies
No one wants to think their company is rife with inefficiencies, but it’s simply a reality of human operations. Nearly every business can find overlooked issues when they take to the magnifying glass of scrutiny. Inefficiencies cost money, whether they’re simply minor time wasters or serious cases of fraud. When was the last time you took inventory of your automatic (but unused) subscriptions? Do you waste man hours on repetitive or redundant tasks? It’s affecting your bottom line.
Tightening up your existing processes and procedures can eliminate costly errors as well as saving time for your employees to focus on productive work. Did you know that occupational fraud affects nearly all businesses and according to the 2018 annual report by the Association of Certified Fraud Examiners (ACFE), internal fraud “is likely the largest and most prevalent threat” to organizational resources. Some businesses have found success by offering rewards for employees who identify inefficiencies or even “whistle blow.”
Increasing cash flow
If cutting your operating costs and expenses is proving difficult, or you simply want to move the financial needle faster, you can also target some strategies that will increase your cash flow coming in. Increasing the denominator of revenue can naturally minimize the chunk you’re losing to operating costs and help maintain a healthy capital structure. Try a few of these ideas to bring in more cash for your business:
- Increase prices, especially of popular items or services
- Invoice customers more quickly
- Decrease payment windows and follow up on unpaid invoices
- Employ a business line of credit
- Bring in new business with better marketing
- Sell or rent unused space or equipment