The challenge of growing a business includes determining which aspect of managing financial performance should take top priority. I have worked in organizations that focused on costs and others that organized around profit centers. There are benefits and drawbacks to each. How you choose to focus your business performance toward costs, revenues, or a combination depends on your business, how and where it operates, the industry, and a number of other factors.
The Cost Perspective: Control, Prevent, and Eliminate
I’ve worked in and with many businesses with a cost focus. Working from this perspective, they would manage the cost of products, service, and total business leveraging a strategy to:
- Prevent a cost from being incurred or embedded in the business
- Control a cost from growing disproportionately to the benefit it generated
- Eliminate costs that:
- Don’t produce results;
- Occurred because of misaligned priorities;
- Were because cost controls and prevention failed; and
- Were produced from outdated processes, controls, and policies.
Each of these cost approaches can be highly effective. They can also be dangerous if the cost focus means you and your team cut not just the fat but get into the muscle of your business. Go too lean and you can starve your organization of capacity and ability to respond.
Real World Cost Crisis
You may also find that new opportunities get passed by because of the “cost” of undertaking them. I worked briefly for a manufacturing company that needed to overhaul all of its production equipment. Shortly after I joined them, the machines began generating a substandard product that would either need to be reworked or scrapped. Our 99% on-time and complete delivery rating to the big box stores plummeted. Our cost of labor and materials was soaring.
When I looked at the numbers, I found that the payback on overhauling the equipment was less than three years before the quality issues arose. With the quality problems and the costs of materials, etc., the payback period would be one year. The only issue? My boss created a rule that we didn’t incur expenses if they didn’t pay back in the same calendar year (our financial year).
Soon we had over 40 storage containers of product awaiting rework. We had scrap rates of 25% or more. The equipment that had been working well was in the same shape as those we wanted to overhaul and repair because they added additional shifts and maintenance downtime canceled. Costs were rising exponentially!
The Cost of Not Spending
Having a focus on costs must include recognition of long-term business growth goals and short- and near-term investment in systems including maintenance and repair. There also has to be criteria in place to recognize that some costs are in reality the current portion of the long-term capacity building and investment in new opportunities. Without these things, a business dies an ugly death.
The Revenue Perspective: Grow!
You would think that a focus on the top line would produce great results. In fact, it can. It can also have a detrimental impact on the business. When top-line revenue results without a thought to margins, profits, or cash flow.
Many of my clients call for help with their profitability and business growth strategies. The first thing we do is to dive into the numbers to see what they tell us about the operations of the business: what is working and what isn’t; what is being done and what isn’t. Yes, the numbers, done well and promptly, can keep a business on top of the operational picture, aid in diagnosing business development and marketing results, and help you check the pulse of client relationships.
Bigger, But Not Better
Some of my clients have doubled the size of their business in just five years, but they are struggling to stay in business. Why? Because the focus on the top-line revenue number was all, they focused on.
You see, healthy business growth takes cash. Unhealthy business growth takes, even more, money. What? Yes, weak growth uses more funds because of the waste (inefficiencies) and ineffectiveness (things don’t generate results). When you focus on revenue generation, you can’t focus on it to the extent that you sacrifice margins, profits, and cash (payments from customers).
You and your team can give deep discounts, longer payment terms, grant credit to customers you wouldn’t have in the past, and do many other things to entice customers to buy. If those incentives and other methods cut into your margins and leave little or no profit (even create a loss) and you give extended payment terms? Your business can’t sustain itself and creditors won’t find you a viable borrower.
Some firms organize as profit centers, where both revenue and cost come into play. They focus on the bottom line, usually earnings before interest, taxes, depreciation and amortization (EBITDA).
So the bottom line reflects how well you have managed to grow your revenues, the cost of delivering the product/services to the customer, the cost of sales/marketing/business development, and of operating the business. By running your business with a focus on making decisions, that improve profitability long term, you can strategically decide when to:
- cut margins to generate more sales,
- when to change credit terms to capture more customers, and
- do all the other things that enable a business to grow and still make profits and cash to run the business.
You have to look at every decision and decide if the trade-off between revenues and expenses (costs and investments) supports the business goals and priorities.
If you want more sales and cash flowing in, you may decide to offer cash price-and-payment incentives. For example, if you purchase $10,000 in merchandise and pay cash within ten days of purchase, we’ll give you 1% discount. You would do this if the 1% discount didn’t eliminate profits. You might also do this if you had a short-term cash crunch and the tradeoff for moving sales up, getting money in, and cutting into profits was the “cheaper” alternative to external funding.
Choose Your Perspective Wisely
There are no wrong answers. You decide how to run your business. There are, however, wrong ways to apply and use these approaches. Whichever option you choose, take the time to:
- define decision-making criteria,
- set priorities, and
- align performance objectives
so that long-term health isn’t sacrificed to short-term performance. Have a balance of short and long-term metrics to measure the performance of:
- The organization,
- Business units,
- Product lines,
- Teams, and
Keep a hand on the pulse of your organization and have visibility in the numbers and in lines of communication to know when decisions are deviating from the prescribed path. By understanding how each decision impacts: cash (C), profits (P), and revenues (R), your business can avoid the need for intervention and CPR.
 A quick side trip: no company can ignore the impact of interest (financing the business), taxes (government mandated rates), depreciation /amortization (cost recovery for reinvestment back into the firm capacity – equipment, intellectual property, software, etc.), for long. These are long-term strategic decisions that have to be made, managed, and revisited to maximize performance. But they are not operational decisions, so they won’t be addressed here.
Copyright ©2016 Lea A. Strickland, F.O.C.U.S. Resource, Inc.