Welcome to week 10 of our 2020 #BusinessChallenge.
Last week we showed you how to cut costs in your business. This is an exercise that should be performed often during the year and not just an “oh, our costs are too much, let’s start a cost optimisation process” exercise.
This week we will focus on the Cost of Sales line item.
The biggest cost in your business
The Cost Of Sales line item is normally the biggest expense in a business which sells goods. In a service business, it might not be as big, but when you consider your employees who deliver your service as a Cost Of Sale, then it should also be the biggest cost in your business.
The accounting treatment of how you decide to acknowledge which costs count as Cost Of Sales is very important. This will determine how you measure Gross Profit and thus the actual profitability of your direct operations.
It happens too often that entrepreneurs do not allocate the direct costs needed to generate their turnover to Cost Of Sales. This will cause you to either underprice or overprice your products or services in the market.
Including items which do not really form part of Cost Of Sales will cause you to be priced out of the market when compared to your competitors.
Excluding items which do form a part of Cost Of Sales will cause you to be well underpriced when compared to your competitors which can cause potential customers to wonder whether you are really worth using.
Homework for this week
This week is a fairly easy exercise.
I want you to sit and think (without looking at your financial statements) what direct costs you incur to generate your turnover. Write them down in a list format.
For a product business, you have to include things like warehouse space, transport, electricity, direct employees etc. For a service business, you have to look at service staff, vehicles, laptop costs, tools etc.
Once you have your list of direct expenses, compare them to your financial statements and see if they correlate.
If your financial statements include items which you did not write down, ask your accountant why they were included. There might be a perfectly logical reason for the inclusion or why you left it out.
If your financial statements do not include all the items you wrote down, ask your accountant why they are excluded. Once again, there might be a perfectly logical reason for the exclusion. If not, they should be included.
The purpose of this week’s exercise, before we even consider cost-cutting, is to understand why the Cost Of Sales line exists in your business and what expenses it is comprised of.
You need to understand why you have this cost in your business and what the real value of it is. Just giving an answer like “well it exists because I need to buy things to be able to sell it” does not suffice.
Sometimes, you do not need to buy all the things you think you need to buy. Say that out loud 5 times to yourself and let it sink in…
Next week we will look at how to start a cost-cutting exercise for this extremely important line item.