Managing business costs to stay lean
During a period of economic stability, business owners are usually more relaxed about expenses and take actions as required for cost management rather than applying it as a business process. With the current pandemic, many business owners are operating in survival mode whilst reviewing their cost base at a microscopic level.
Managing cost is a process that business owners must implement throughout the business cycle. Pramod Dhalwani, CEO and Founder of IFC Group, shares his insights into managing business costs through a simple acronym for this process, developed from his 28 years of research and practical application. It is PAIR, also defined as Plan, Assign Accountability, Inspection Rhythm and Revise.
1) Plan: There are three types of costs that businesses incur:
Cost of Sale, which are direct costs related to producing goods or service for sale. Managing this improves gross profit.
Opex, which are operational costs e.g. rent, support staff etc. Managing this improves net profit.
Capex which are capital expenditure e.g. purchase of Machinery for production, IT equipment etc. Managing this ensures a better ROI.
There are two ways of managing costs – planned and ad-hoc. The planned approach complexity depends on the size of business and can be created either on a spreadsheet or budgeting software. As an SME, the use of a spreadsheet is sufficient for the purpose.
2) Assign Accountability: This is the execution step. Based on the experience of working with SMEs across the globe, many businesses create a plan that is filed away, rather than used as a reference point for accountability.
Every single line item in the planned expenditure, be it Capex or Opex, should be allocated to an individual with accountability defined. The metrics set should be based on the nature of the cost. For example, software subscription costs limit can be set per employee or company-wide depending on the type of business.
3) Inspection Rhythm: A robust accounting process should be implemented to inspect and capture costs to provide accurate and timely data. This data should be available to the person accountable so that they can inspect it at any time to ensure compliance with the plan.
The costs within the business are interdependent, making it imperative for a collective inspection rhythm to ensure costs are on track. The impact in total of the variation needs to be reviewed to ensure that overall costs are also managed, not just the individual elements.
Adopting the lean mindset can generate significant savings by eliminating waste and thereby reduce costs. Every business from start-up to large corporates have some form of wastage. If a certain manufacturing process does not have a zero-error rate, there are costs associated with reproducing or correcting the errors. By eliminating errors, business can manage and reduce cost. One of the recommended books for reading is 2 Second Lean: How to Grow People and Build a Fun Lean Culture by Paul Akers.
4) Revise: We live in a dynamic world where the speed of change is at an accelerated pace. This step allows business owners to review their progress to date, re-validate the original assumption identified at the planning stage and then course correct, as necessary.
Firstly, identify the variances between actual and budget and then prepare a revised forecast. For example, forecasts prepared in May need to include April actuals and estimates from May to December based on revised assumptions.
For successfully managing business costs to stay lean, it is recommended that every business owner execute the PAIR methodology sequentially, whilst keeping the three ABCs in mind: Adopt a process-driven approach; Build flexibility within the cost base and Create a lean culture.