Cost Cutting – A Traditional Approach to Poor Financial Performance

Cutting costs is often the first action when profitability doesn’t reach expectations or needs.  This is can be a dangerous first step which speeds the downward spiral of performance.  Cost cutting without understanding the impact on things such as productivity and capacity can greatly impair the ability of the organization to compete.

One example of impairing capacity is when a technology company lays-off technology workers who required eighteen months to train.  If the organization is able to improve sales, then the lay-offs may impact its ability to meet the technological support of those sales.

Cost cutting is relatively easy to do.  The implications to the business in the long term and the overall sustainable effectiveness of cost cutting are more difficult to capture.  The implications of changes in infrastructure, the impact of outsourcing, and a multitude of other major and minor initiatives which determine what he business needs to be “successful” are numerous and varied.

Before undertaking unilateral cost cutting, the organization must do the following:

  1. Understand where current financial performance is generated – the good, the bad, and the indifferent
  2. Tie current performance to specific activities, customers, and processes
  3. Determine what  the core business activities and areas of critical expertise are and what needs to be protected to maintain “adequate” revenue generating capacity
  4. Understand what business operations are necessary to:
    1. Monitor and report on internal activity (manage the business)
    2. Measure performance
    3. File and report to external stakeholders (pay the bills, taxes, etc.)
  5. Quantify the cost of processes, activities, customers, and products
  6. Understand the time requirements for restoring capacity
  7. Identify organizational constraints on revenues
  8. Develop strategies for improving quality of revenues as well as quantity
  9. Analyze industry, competitor, and general economic conditions
  10. Prioritize projects and activities

This is the reality:  every organization must survive the near term without irrevocably impairing its ability to have a long term.  The ability to take actions which preserve the organization’s capacity and revenue generating capability and reduce the burn rate (cash consumption rate) is the make or break ability of organizational success – regardless of the stage of business.

Instead of cutting costs, organizations should focus on preventing unnecessary costs from getting into the system.  The ability to detect “cost creep” resides in the organization’s internal monitoring systems, including meaningful and measurable management accounting, business analysis, and performance metrics.

The organization which understands

  • growth requires cash
  • cash and revenues are not necessarily equal
  • profits and cash are not the same
  • cash flow is a factor of credit terms extended and received, as well as the levels of investment in productive inputs (labor, equipment, etc.)
  • big sales don’t equate to big profits
  • sometimes certain customers are too expensive to retain
  • it is easier to retain an existing customer than to identify, close, and deliver to a new customer

is the organization that is truly capable of success.  The saying “know thyself” is truly applicable to the success of an organization.  Stepping away from reactionary, “traditional” approaches to poor financial performance takes the ability to delay action in the face of intense pressures.  Acting too quickly, without understanding the ramifications of cost cutting measures may the final straw.

Before your organization is faced with a cost-cutting situation, build the capability to understand the activities and performance of the organization.  Make the connection between cause and effect.  Measure performance and monitor what is happening in your organization.  Identify the danger signs and signals of overspending, poor allocation of resources, and other symptoms which indicate the organization needs to take corrective action BEFORE the only option is cutting into the revenue and operational capacity of your business.

Copyright ©2006 FOCUS Resource, Inc.

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