AS business owners/managers we often place more focus on selling than on buying, and that’s natural. But if you can spend a little time looking at costs, it can improve your profits noticeably.
A small reduction in costs can often achieve a better result on the ‘bottom line than a large increase in sales, and often its a lot easier to achieve.
There are generally two types of costs in business, being direct costs or COGS (cost of good sold) and indirect overheads.
COGS are sometimes referred to as COS (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. For example, 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 income. Gross profit is an important indicator of business performance and an important benchmark against which to measure a business to others.
A wide range of costs are classified as COGS including purchase of stock to sell, movement in stock held (what was held at the beginning of an accounting period versus what was held at the end), freight costs to get goods into and out of stock, labour costs relating to production of a service or product, importing costs, discounts given, stock wastage, purchase returns and allowances, raw materials, and packaging.
COGS are 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.
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.
Budgeting for COGS is an important function in monitoring profitability. COGS can very easily ‘creep up’ without you realising 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.
* Sue Hirst is a director of CAD Partners, a team of financial controllers; 1300 36 24 36. MM readers can receive a free e-book on cashflow control, visit www.cadpartners.biz/Directory/Document_PublicView.asp?Select=12435&site=421.