Increasing sales is important to any profit enhancement plan. But cost cutting cannot be left out. If you are operating on a 10 percent net profit margin, a $1 cost reduction is equal to a $10 increase in sales.
In order to achieve lower costs, you should perform a cost-cutting audit annually. In this video I cover how successful cost cutting requires you to follow three simple but painful rules.
Increasing sales is important to any profit enhancement plan. But cost cutting cannot be left out. If you are operating on a 10 percent net profit margin, a $1 cost reduction is equal to a $10 increase in sales.
In order to achieve lower costs, you should perform a cost-cutting audit annually. First, identify your biggest costs and assign them to cost centers. Then use those centers to allocate the remaining costs. Once you categorize your costs and understand their relationship to your business, you can implement cost cutting. All companies attempt to do cost cutting, but they often fail.
Successful cost cutting requires you to follow three simple but painful rules:
- Make cost cutting a continuous activity. Most companies have cost-cutting drives at intervals of several years, and generally only during business downturns. In between, only a token effort is made to run economically. You can win big by having all of your managers work on cost cutting every day. Require a written report on their progress on cost reduction every quarter. This not only reduces problems in bad times, but can substantially increase your cash flow during the boom times. This is a much more efficient way to cut costs. Crash programs tend to result in process hang-ups and quality problems because the measures taken are not thought out and are implemented in a hurry. Continuous cost cutting gives you the opportunity to carefully test results and avoid false economies.
- Cut the major costs first. It seems obvious to start where the money is. Unfortunately, I have sat through countless meetings where the cost cutting applied to as little as one percent of the total costs. Be creative! Look for ways to cut costs that don’t affect efficiency or reduce your product’s quality.
- Cut costs by eliminating, not reducing, activities wherever you can. As you examine each cost and cost center, the first question you should ask is, “Can we get rid of this entirely?” The answer of course will probably be “No!” You can jar your people out of that rut by rephrasing your question like this: “Okay, suppose we were forced to stop doing it. What would we do instead? Would it be cheaper?” Don't even consider your options for reducing the cost of an activity until you have convincing evidence that it is impossible to eliminate it altogether.