Just as cash is king in any business, so too, are costs. Cost containment is absolutely essential for any business that wants to improve its margins and overall profitability. We’ll take a look at some of the key cost containment strategies you can use in your business.
What Is Cost Containment?
Cost containment is basically the practice of recording and controlling expenses to ensure that a business has minimal to no overspending, while still ensuring that the business can run at an optimum level. This means that cost reduction should not come at the expense of a business’ long-term profitability or success.
Effective cost containment is important for any business. Often, a business’ services or products have set prices. This means that they can only increase profit by increasing sales volume. Conversely, costs can increase at any point during a financial year, with any such increases eating into profit margins. Excessive expenses in a business damage both gross and net profit margins. Further, overspending can drain cash, which is a key resource for any liquid business.
However, if a business can employ practices that minimize expenses, or better yet, prevent overspending before it occurs, then both margin and cash flow can improve. Healthier profit margins are good news for any business and its shareholders. As a result, good cost containment strategies are critical.
Cost Containment Strategies
There are a number of ways you can effectively manage costs in your business. Below are some of the most common strategies that are easy to implement.
Review business spending
The first step in implementing an effective cost containment process in your business is to keep track of your existing expenses.
Ideally, you should look to track your expenses on a daily basis, and at a minimum monthly. This is so you can see what expenses increase or decrease in cost over time. In particular, see whether there are any patterns on a monthly, quarterly, or annual basis. This is because there may be a reason for a short period of overspending.
For example, utility bills for gas and electricity may well fluctuate over the year due to colder months driving up energy prices. However, if you notice that, for instance, stationary costs trebled during Q3, you may want to drill down further to understand why such a large increase occurred.
Additionally, you should look to track each of your costs against their respective budget on a monthly, quarterly, and annual basis. This is so you can easily pinpoint which costs are over budget upon review.
The key thing is that when you do spot irregular or unexpected patterns of spending, you investigate the cause for that particular overspend. You could speak to the purchaser if you know who authorized the purchase. Alternatively, ask someone to look over itemized invoices, so you can see what exactly what was purchased with the money and whether its cost is justifiable.
Once you know the reasons why expenses may be high, you can implement daily or monthly caps on certain expenses, such as travel or entertainment. Alternatively, you could look at implementing more cost-effective measures. For example, you could hire employees rather than contractors to reduce your labor costs or vice versa.
Check the profitability of your products and services
Any cost containment strategy should seek to prop your business up in the long-term. Additionally, a good cost containment strategy should not harm margins in any way.
One effective way of keeping profitability high is to review the margins on your product or service lines. A quick review of the profit margins should show you which products are making the most money for the business. Additionally, the review should show which lines aren’t doing as well.
Adapt for success
Once you have this information, you could change the strategy of your business so that you focus more on the products that are doing well. This should hopefully lead to increased revenue for those particular lines. This may mean dropping less successful lines or reducing their marketing efforts. But this should not have an impact on the overall profitability of the business.
When focusing on your most successful products, you should also ensure that there continues to be a marketing and sales budget for those lines. This is because you don’t want to cut costs on successful products that may compromise on their quality or on their branding or sales potential. You can achieve this by implementing a minimum marketing spend on certain product lines. However, make sure that the minimum spend is proportionate to the amount of turnover those products generate.
Negotiate better payment terms
If you have reviewed your business’ costs and can’t identify any expenses that appear unnecessary, or that have clear signs of overspending, then there is another way to reduce your business’ expenses.
The first is to speak to your main suppliers for your biggest expense items. In doing so, you may be able to negotiate better prices for the items you buy. You may also be able to negotiate longer credit periods, which can improve cash flow.
However, it can be difficult to negotiate better payment terms with a supplier in the early stages of a business’ life. This is because it can take time to build enough trust with a supplier to gain more beneficial rates or payment terms.
If the supplier is open to discussion, try to see whether they can provide reduced rates if you buy items in bulk. You could even try to negotiate them down on the unit price of each item you buy. You never know unless you ask, so it’s worth a try.
How to Improve Profitability of Your Business
One key metric you can use as part of your cost containment strategy is to look at the return on investment you are getting from all parts of your business. This metric can tell you how efficient your business is at managing costs. It can also provide an indication of how profitable your business is.
Return on investment, or ROI for short, is a profitability ratio shown as a percentage. As such, it shows how much profit an investment generates.
ROI is calculated as:
((Gain on investment – cost of investment) / cost of investment)
Alternatively, you can find a return on investment calculator easily on the internet, which will do all the calculations for you.
Make ROI Work for You
You can calculate the ROI for all areas where you think your business may be overspending. Whether that means the marketing department or labor costs, you can assess how profitable those departments are and whether the costs they incur are justified.
Overall, there are a number of cost containment strategies you can employ in your business. From reviewing costs on a regular basis to negotiating better prices with vendors and conducting an extensive ROI analysis, there are many ways that your business can minimize costs.
A reduction in costs means improved profitability and helps contribute to the longevity of the business. So, today has never been a better time to start looking at how to maximize cost efficiency in your business.