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8. How to improve profits and financial stability: One common way of increasing profits is to push for higher sales. Great sums may be spent on advertising or marginal product differentiation and the sales force is whipped into action. If your company has a 10% pretax profit margin, the implication, however, is that for every single dollar targeted for increased profit, the sales team must sell an additional $11 of your product. On the other hand, the bulk of every dollar removed from the cost structure reports directly to the bottom line as pretax profit. In the following highly simplified example, a 10% reduction in expense provides a 9% increase in pre-tax profits. A 10% increase in revenues, on the other hand, provides a 1% increase in pre-tax profits. Thus, a better and faster way to improve profits is to reduce expenses through cost reductions.
NOTE: This is a very simplistic example. The impact on your bottom line of a reduction in cost or an increase in sales could be smaller or greater depending on the exact nature of your expense structure. Consider key elements such as economies of scale and fixed, variable, and incremental costs carefully. It usually helps to have your cost and accounting people on your team to help find, evaluate, and measure opportunities. 9. What expenses can be targeted for reduction and how can they be found? Expense reports are the most logical place to start the investigation. Start by picking a relatively long period of time such as a year to ensure that you capture any seasonal variations. Categorize expenses by type (e.g. hourly labor, salary, benefits, materials, supplies, maintenance, contract purchases, rent, etc.) and then list them in descending order. Use the Pareto Principle to select the first targets (see sidebar for a definition). This allows one to narrow the list and pick hot targets more quickly and effectively than using a random approach. Further sort the targets with criteria such as how readily the expense be can changed. Do you have control or is it fixed? Remember that even "fixed" expenses may have a degree of flexibility. If, for example, expenses cannot be reduced on a surplus building, subleasing it, tearing it down, selling it, or moving could make a cost reduction possible.
The Pareto Principle Vilfredo Pareto, a Swiss economist (1848-1923) found that typically 80% of the "value" of a population is found in only 20% of the number in the population. In other words the top 20% of the expense accounts that you have will probably include 80% of the total expense dollar amount. Applied to sales, companies often see that only 20% of their customers (by count) will account for 80% of their total sales.
Having selected targets and evaluated the type and extent of control you have over them, the next step is to generate ideas for reduction. The ideas should be evaluated against key selection criteria and then converted into options (see the note below for some example evaluation criteria). The criteria may be used as go-no-go gate decisions or for rank ordering the options with a scoring system you devise. Options may then be further evaluated for implementation.
Evaluation Criteria
It is imperative that you evaluate options against the criteria that are most important to your organization. A failure to do so could result in less than satisfactory choices or unexpected negative fallout. 10. What tactics can be used to reduce expenses? Applying any or all of the following types of tactics can reduce costs:
(c) 1998 - 2008 Steven C. Martin, Business Solutions. All rights reserved. The contents of this paper are copyrighted and, as such, may be used for personal use only. Duplication and/or commercial use of this material is expressly prohibited without written permission of the author.
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Cost Reduction & Profit Improvement
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