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Is your business feeling the squeeze from inflation, the tight labor market, or supply chain issues? When you need to increase your cash flow, you have two options—increase your revenue or cut your costs. Here, we’re going to dig into cost-cutting. Learn what it is, what can go wrong, and the different ways real business owners reduce their costs during lean seasons.
What is cost cutting?
Cost cutting, or cost reduction, is the process of reducing your business expenses in an effort to increase your profitability—typically in the short term. It involves reviewing all of your expenses and identifying those which can be reduced or eliminated with the least impact on your company’s profitability and customer satisfaction. For example, it could mean allowing employees to work from home in order to downsize to a smaller office space. Cost cuts are typically made during an economic downturn to increase liquidity and meet profitability expectations.
How do you manage cost-cutting?
First, don’t cut costs frantically as a knee-jerk reaction. Gartner, a technological research and consulting firm, recommends a thoughtful approach that considers both short-term cost-cutting steps and longer-term cost-optimization steps, all within the framework of how they impact your revenue growth.
A good first step is to take inventory of all of your expenses. Then, organize them by how valuable they are to your business’s growth and bottom line. Gartner said, “Just because certain cost types can be removed more quickly doesn’t mean they’re less valuable to business growth.” Categorize the costs by their impact on revenue from high to low. Then, go through them to determine what you may be able to reduce or eliminate—starting with the costs that have the lowest impact on your revenue.
Why is cutting costs important?
When revenue is growing month over month and year over year, businesses may find themselves investing more and being less scrupulous about where every dollar is going. However, when growth slows and profitability is waning, how a business is spending money becomes critical. Cutting costs can enable you to retain enough revenue to cover all of your expenses and survive down periods—like a recession or pandemic. However, if the wrong costs are cut, it could hurt your business’s profitability, customer satisfaction, reputation, and/or company culture. The fallout from that can make it difficult to recover. Therefore, it’s important to strategically and thoughtfully choose which costs to cut.
What is the difference between cost-cutting and cost-efficiency?
The difference between cost-cutting and cost-efficiency is that cost-cutting refers to reducing costs while cost-efficiency refers to ensuring that every dollar is being used in the best way possible. For example, if you decide that your business’s labor expenses are too high, you may cut costs by letting in-house employees go. On the other hand, you could improve your cost efficiency by examining your employee benefits packages (health care, retirement, other perks) to see if they’re optimized for cost and employee satisfaction.
What are the benefits of cost-cutting?
The immediate benefit of cost-cutting is the increase in your bottom line. You can reduce expenses that are absorbing your revenue and increase your cash flow. When done strategically, without a minimal negative impact on revenue, it can help your company survive economic downturns. Then, when things begin to turn around, you’ll have the cash flow available to reinvest into expenses with a higher return on investment.
What happens if you cut costs too much? Is that possible?
It is possible to cut your costs too far. You’ll know if the losses outweigh the savings. For example, if you cut down your business’s data plan and then go over the data limit resulting in overage charges, that cost cut wouldn’t make sense. Similarly, if you lay off your best sales representative and then lose more revenue than you save, you suffer a net loss. It’s important to cut expenses that won’t cost your bottom line more than they will save it.
What are some ways to cut costs?
So, how can your company cut costs? We asked a few business owners to weigh in. Here’s what they had to say.
Software, photoshoots, and education
Jen Hartman, CEO of NEAT Marketing, said, “Expensive software would be the first to go. We spend roughly $600 each month on different software tools so we would definitely eliminate some of those tools!”
She added, “I would want to prevent letting go of any team members so I would take a pay cut and that would reduce our overhead.”
Hartman also mentioned she would cut photo shoots and reduce spending on educational resources like masterminds, courses, and books.
Payment processing fees and subscriptions
Adam Knihtila, a Fractional CFO, said, “A big one is payment processing fees. There are low- or no-cost options out there now instead of paying 2-3%+ on every card purchase.”
Knihtila also mentioned the importance of analyzing your recurring subscriptions to see which you actually need.
Further, Adriana Tica, a marketing strategist, commented on the importance of a lean marketing strategy. She said, “You have to cut the underperformers, but you must do it smartly. For instance, you may be tempted to cut the ads that bring in the fewest conversions and/or have a high cost. But, before you do that, look at CLV (customer lifetime value).”
Tica adds, “Sometimes, 20% of your clients bring in 80% of your revenue. Don't cut the source for that 20%.”
Shop around for business debt, supplies, insurance, and vendors
It can also be a good time to look into the interest rates and fees you’re paying on business debts like loans, lines of credit, and credit cards. Figure out how much you’re paying and shop around. You may be able to refinance at a lower rate to reap cost savings.
For example, a balance transfer business credit card with a promotional no-APR introductory period may be able to eliminate your interest for a limited time. However, you’d want to be sure that your APR wouldn’t increase above your current rate after the period expires. You can also shop around to ensure you’re getting the best deal across the board on things like insurance, supplies, vendors, etc.
Cost-reduction mistakes to avoid
Now that we covered some ways to cut costs, here are a few mistakes to avoid.
- Making blanket cuts: When you make blanket cuts across the board, chances are, you’re going to make cuts that hurt your bottom line, your customers, and your employees.
- Laying off talent: Finding reliable employees and training them requires a large investment, and can be difficult amidst the current competitive job market. Jumping to layoffs can cost you more than it saves.
- Cutting inventory for in-demand products: If you sell products, your top-selling items are the lifeblood of your business. Reducing inventory levels of those products can cause huge hits to revenue and customer loyalty.
- Reducing cybersecurity protection: One area you don’t want to skimp is cybersecurity. With the growing threat of cyber attacks, vulnerability can come with big costs.
- Setting unrealistic targets: According to Gartner, almost half of business owners fail to lower costs as planned. It’s important to ensure that your cost-cutting initiatives and targets are realistic.
- Overlooking organic reach opportunities: Many companies invest a pretty penny in paid marketing. During slower times, it can make sense to lean into organic efforts. For example, building your followings on social media platforms ( LinkedIn, Facebook, TikTok, etc.). These platforms are free to join and use, and can reach large audiences of your ideal customers.
Finding the right cost-cutting strategy for your business
When it comes to cost reduction strategies, there’s no one-size-fits-all solution. Every small business has its own needs, expenses, processes, and priorities. You’ll have to take inventory of all of your expenses and analyze how they impact staff members, customers/clients, and the overall health and profitability of the business. From there, you can begin to trim inefficiencies and lower-impact expenses.
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