10th September, 2015
During the transition from a one-person operation to what some might describe a ‘proper’ business, most businesses tend to go through a period of growing pains where expenses can blow out but revenue does not grow at the same rate.
This can result in a drop in profitability. Many businesses never break through this barrier, and their owners remain frustrated, managing people and resources, working harder and harder, with little or nothing extra to show for their efforts.
There are 3 common positions small businesses find themselves in:
1. A general manager
2. A proficient administration team
3. A sales team
4. Customer service people
5. A full time marketing resource
Many business owners in position 2 above should either revert to position 1 or take the bold step to move up to position 3. Getting stuck in position 2 is a major reason why many businesses ultimately fail. Costs creep up, you get too busy servicing existing customers and there is no resource available to drive new revenue.
The focus of this post is on helping you identify 5 expenses that can sneak up on you and get out of control. I’ll list each of them and provide you with some insights as to how to either mitigate them or make sure you’re getting the best return for each of those expenses.
This can be a killer. I know an extremely well regarded and talented cabinet maker who operated as a sole trader for many years. He was always busy, with a bulging order book created from word of mouth. Then, he decided to hire someone to help him.
I met him recently, and he was bemoaning the trials and tribulations of having someone on his payroll. He couldn’t understand why, having expanded his business, he was now worse off.
Of course, all of the hidden on-costs of employing people are what catch business owners out. And never underestimate your lost time, which finds its way to training, dealing with questions and helping your new employees do things that you could do faster and better yourself.
Another business I know of geared up with all good intentions for expansion into new markets. Its headcount and payroll bill more than doubled in 12 months. Unfortunately, the hoped-for expansion did not materialise in the timeframe the owners had expected, leading to significant stress on cash flow as well as a drop in existing revenue.
Please don’t get me wrong. I am not saying don’t hire people, but if you do, be prepared to take a step back before you move forward.
If you run a retail or manufacturing business, then it’s inevitable that you will incur rent or property ownership costs. But there are many businesses renting office space that are simply throwing money down the drain. Typically solo professional services operations, they take an office because they feel it’s the right thing to do, whereas in reality they would be better off setting themselves up at home without incurring all of the costs associated with setting up a ‘real’ office.
I know an extremely successful consultant who has operated out of his home office for over 25 years. He calculated that he was able to put both of his children through school and university out of cash flow generated by his business and that the tuition fees he paid would have been almost equivalent to what he would have outlaid in rent had he chosen to take an office outside of his home.
If you are renting space and need to do so, look for opportunities to renegotiate your rent on more favourable terms. Look around your town or suburb — many have empty shop fronts right now, indicating that it is not a strong market for landlords. Irrespective, many landlords will push you hard for increased rent in the hope that you won’t push back.
When businesses gear up for growth, they tend to invest heavily in advertising and marketing. I have seen this expense creep up significantly over a three- to four-year period without a commensurate increase in revenue to justify the spend. My recommendation is to break down all of your spend in this area into specific campaigns (for example, Yellow Pages ad, newspaper adverts, direct mail campaigns, local sports club sponsorship, email newsletters, etc.) and track the success of each campaign.
How much new business does each generate, and what is the return on investment? Your aim should be for all marketing campaigns to be profitable, meaning you generate more in new revenue than you spend in marketing. It is important to measure everything, so that you can tweak (or stop) campaigns that are not working and do more of those that are producing positive results.
Hire new people, give them autonomy and freedom to make decisions, send them off to develop new markets — and watch this expense go through the roof! It is important to set some parameters. No one begrudges a team member claiming a moderate subsistence allowance while on the road, but be careful of the upstart salesperson booking one-hour flights in business class to meet unqualified prospects. Clear guidelines on travel expenses set upfront usually deal with these issues.
As your business grows, it becomes more complex, as does your personal situation with regards to asset protection. Any good accountant should be discussing these issues with you to ensure that the structure within which your business is operating is both tax effective and protects you in the event that the worst happens to your business.
The problem is, there may be poor communication around the fees, so it’s not uncommon for a business owner to receive a big bill after all the work is done. To ensure you can manage your expectations around professional fees (and plan your cash flow), insist that your accountant provide you with a fixed fee upfront before they start any work on your behalf. This way, there are no surprises after the event and, importantly, you can weigh up the benefits of having the work done with the investment in that work and make an informed decision as to whether or not to go ahead.
Expenses have a habit of creeping up on you. It is good discipline to review them line-by-line once a year and make a determination as to whether you are getting the absolute best return on investment for each expense.
You might be surprised at the level of needless expenses and the savings you could make by renegotiating some costs — or, indeed, the increased revenue you might see as a result of increasing some expenses that show a great return. Your proactive accountant can help you with this review as well as providing advice on your cost structure in general. They can also give you a hand with setting up a monitoring system to track the return on investment on your marketing expenses.