Costs and profit are the factors one must consider in starting their business. It is both the fuel and the path that you must take as a business owner. People say that one must focus on the outcome, which is generating profit rather than cost reduction. But, how can business owners manage and balance both concepts? This article will learn about the different ways of handling cost reduction and the factors you need to consider to generate revenue.
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What is Profitability
Businesses are viable on a sustained basis if the company’s revenue exceeds the cost of business operations. The difference between the revenue and cost is called profit. Negative profit or loss happens when costs exceed revenue.
Lowering your business costs and increasing your revenue is one of the most important things that business owners need to consider. To increase revenue, one must understand the flow of the market. Lowering costs for the items that are not essential is also an ordeal in cost reduction and sales increase.
Understanding Costs and Revenues
As a business owner, getting ready is having a good understanding of your revenue sources and costs to know what your company should aim at.
Revenue is the total of money gained by the company for selling goods or services in a given time period. Most businesses sell something, either a physical good, such as an ice cream bar or a car repair service. This sale out of goods or services is made in return for money. The total amount of money of goods and services sold is called the revenue.
The cost of goods sold is the costs incurred in the production of the goods. It is a collective expense spent to generate revenue in the long time, expressed in terms of monetary value. It includes the cost of materials with the labor costs in the production of goods. Some cost elements include indirect costs, such as sales force and distribution costs. It is also related to sales volume when sales go up, and costs go up. Other prices include the cost of the machine used in operation.
Which is Important? To Lower Costs or Increase Revenue?
A company cannot purely determine whether it is important to lower costs or increase revenue. Several factors can influence the choice of the company in a given market or economy. One of the keys to financial stability and constantly growing profits is a specific marketing focus.
Cost-cutting refers to the method the company implements in cost reduction and increases profitability. Lowering the cost is usually implemented by companies during financial distress or economic downturns. Some companies use this method if the management expects profitability problems in the future, wherein cost-cutting can be part of the business strategy.
Lowering the cost increases profitability, given that the sales prices and the number of sales remain the same. If the cost reduction affects the decrease in the quality of the products, the company might be forced to reduce prices to keep sales the same. This can decimate the potential gains and may lead to net loss. Over time, a tremendous negative impact may happen from a continuous loss of market share due to the reduction in quality as it will be difficult to maintain sales sums. If a company will cut costs and there is no reduction in the quality produced and sales price, then chances of increased profitability are higher. Some common measures of lowering charges are looking out for excessive payroll costs, rising supplies, and increasing shipping fees. Whenever you cut charges, revenue gain increases, and it creates a higher return.
What Happens When Costs are Higher than Revenue
The income statement of the company lists down the company’s revenues and expenses. It is also called the profit and loss report, a financial report that shows the profit margin or loss of a company for a certain period. When the revenue is higher than expenses, the result will be the net income or called profit. It comes from subtracting costs from the revenue. However, when expenses are higher than revenue, revenue minus expenses will result in net loss or loss.
An expense or cost is the money the company spends to operate the business. If you cut payments or funds the company spends on its primary operations, it may negatively affect your company’s revenues. Net income is revenue minus expenses, so if lowering revenues recklessly by reducing on your operating costs, your plan of reducing costs will have no impact on your company’s profit margin.
Ways to Cut Your Company Expenses
One way to cut the costs with less impact on the company’s net income is to spend less on your business needs. Make sure to get the lowest prices for office supplies, use refurbished equipment and furniture, renegotiate contracts when they expire. You may also look for a cheaper office, but you should consider the moving fees to ensure your net income’s positive impact in the long term. Only employees who need electronic gadgets like laptops and smartphones in their jobs should get them. Get rid of extra inventory and evaluate your company labor needs.
Keep Revenue Up
Look for a supplier that sells quality standard supplies for a lower price. Do not settle for lower quality items that are cheaper because it will lower your products’ quality, damage your brand, and reduce revenue. It is not good to buy cheaper, low-quality safety equipment since it will endanger your employees and hurt their morale.
Benefits and Salaries
Decreasing salaries and benefits can hurt your employees’ morale, negatively affecting the productivity of your goods and increasing your employee’s turnover. The need to find and train new employees will incur your company additional charges, and new employees have less experience and not as productive as the original employees.
Difference Between Cost Avoidance and Cost Savings
In business, keeping rates down and reducing fees is just smart. The more you can keep revenue and cash flow, the higher profitability there will be. Cost-saving is referred to as “hard savings” or any action that results in a tangible benefit that reduces current spending, investment, or debt levels. Cost avoidance refers to “soft savings” or any activity that can prevent incurring any costs in the future.
Cost savings are associated with actions that result in a tangible benefit that reduces current spending, debt levels, or investment. An organization’s financial statements should highlight any savings achieved through the cost-savings measures. Planned cost savings should be included in the budget plan. It should be added to financial statements so that the company can effectively measure the cost savings regarding profit.
Unlike cost savings, cost avoidance refers to actions that avoid incurring potential costs in the future. It means taking measures to reduce potential increased costs, so the company does not have to deal with many future costs. Cost avoidance actions are taken to minimize and avoid possible future costs. For instance, if your company spends to address maintenance and to keep everything working well and in order, you may need more expensive repairs or replacements in the future. If a company allows its employee to drive vehicles or equipment in poor conditions, there are more chances of an accident that may go far behind repairing the vehicle.
Any action taken to avoid prospective costs increase in the future is cost avoidance. It is something that you are not able to see or measure in the company’s budget or financial statements. Because cost avoidance may require spending funds as an additional cost in the short run, wherein costs will temporarily increase. But this additional money spent now will lower costs in the future, bringing the total cost down.
Cost savings and cost avoidance are commonly confused or used interchangeably. These two phrases have different meanings, and knowing them can significantly change your overall business operations. So if you are going to use these terms in investment, make sure you are using them correctly. Cost savings methods are shown in financial statements and records of annual budgets. But cost avoidance methods are never reflected in financial statements on the yearly budget. They are only shown when a proposed action is not implemented, resulting in a cost increase.
The Bottom Line
Expenses have a way of creeping up. So you have to keep an eye on them or else they can eat into your company’s profit. It can help if you find ways to cut costs in a certain period. It does not mean you have to lower your quality standards, cut back productivity or lower your profit goals. But, you can reduce costs while keeping the quality of your products or services.
There are many factors and strategies that a company can consider in increasing revenues or significantly reducing costs. Having the right knowledge about these terms can help the company function at its best and successfully thrive in the market even if it has to meet economic downturns.