Get to know your cost structures
When we start working with a business, one of the first things we do is review their historical Profit and Loss to get an understanding of sales growth and channels, margins, and cost structures. Whilst all really important, we often find business owners have a great handle on what drives their sales but not so much their costs.
The distinction between variable and fixed costs is an important one and the best businesses recognise this. To remain agile and be in a position to quickly react to changing market conditions requires intimate understanding of what cost are locked in versus those that are flexible, those that are business critical versus those that are nice to have and those that are lead or sales generators versus those that won’t bring an extra dollar through the door.
So what does this all mean and what are the benefits of minimising your fixed costs? Well let’s start with some basic definitions like what are fixed and variable costs?
Put simply, variable costs are those that are directly tied to sales transactions. They’ll increase as sales volumes go up and decrease as sales go down. Variable costs include inventory, freight and handling, packaging and transaction fees.
Fixed costs on the other hand are costs that have to be paid regardless of sales volumes. Often they are contracted amounts are can be costly to cancel or take some time to wind down. They include expenses like rent, council rates, utilities, salaries for permanent employees and insurances.
As fixed costs don’t fluctuate with sales volumes, it can mean that any drop in sales can leave a business exposed with very little ability to reduce their expenses and maintain profit margins. The key is to get the right balance between fixed and variable costs to ensure you have enough flexibility in your cost structures enabling you to act quickly if required.
Unfortunately, there isn’t one cost model to fit all businesses. The right balance between variable and fixed costs will vary from business to business, however if you feel that your structure is quite fixed here are some ways to increase flexibility:
Employing contractors or utilising labour hire services instead of employing permanent employees
Not entering into fixed fee monthly service contracts commonly seen for IT or HR services, instead paying for services as required
Utilising the services of a 3PL warehouse reducing the need to pay rent on large warehouse spaces
As always there is a cost versus benefit for each of these options and they may not be suitable for all businesses. For example, a pay as you go service contract may be charged at a higher hourly rate than a fixed fee monthly contract. However the ability to be agile and react quickly to change could be priceless when times get tough.
If you’d like to better understand the cost structures in your business touch base at info@brambleandbriar.com.au.