Welcome to week 11 of our 2020 #BusinessChallenge!
We are still discussing the all-important topic of cost-cutting and how to do it wisely without compromising your business. Your business operations can never be worse off while you perform this exercise.
If your operations have been negatively affected with longer lead times, reduced quality or non-delivery of orders, then you are doing it wrong.
This week we focus further on the biggest and most important expense line item. Cost of Sales. Last week was all about WHY you have a Cost of Sales line item in your business.
Ok Tiaan, so where do I start?
Let’s start with the exercise from last week.
You should by now have a full list of the items which comprises your business’ Cost of Sales. So you should understand exactly how your business calculates and accounts for raw materials, labour costs and direct overheads.
Let’s now use the widget production example of Week 2. The first Cost Goal was to decrease the cost of manufacturing Widget A with R3.00 per unit to increase the gross profit.
In order to decrease the cost of manufacturing Widget A, you would have to know what the cost comprises of.
Let us assume that the cost of producing one of Widget A comprises of the following costs:
- Raw Materials: R28.56 (ex VAT)
- Labour Costs: R11.78
- Direct Overheads: R21.45 (ex VAT)
- Total Cost per unit of R61.79 (ex VAT)
I always advise all my clients that I only want to find a 5% decrease at a time. The reason I do not ask for more than 5% is as follows:
- Is it realistic to ask for any decrease of more than 5% in the first place?
- When you focus on a decrease of more than 5%, the numbers get too big to find improvements.
- Small decreases are easy to find. Once it has been implemented, its easier to find another 5% improvement.
The magic of finding a 5% improvement
Let us now use the 5% reduction on Widget A costs. If we reduce each cost by 5%, we will have the following new costs:
- Raw Materials: R27.13 (ex VAT)
- Labour Costs: R11.19
- Direct Overheads: R20.38 (ex VAT)
- Total Cost per unit of R58.70 (ex VAT)
The total saving on the Cost of Sale (or production Cost) of Widget A is R3.09. So we have achieved our goal of reducing the production cost by R3.00!
Tiaan, you forgot to show me how to reduce each cost by 5%!
Well Sir/Ma’am, you have to figure some stuff out on your own as well!
But, let me give you some pointers:
- Talk to your raw material suppliers. Maybe they offer discounts on bulk purchases, discounts on early payment, discount on bundled purchases. Just phone them and ask what they offer.
- You cannot reduce the hourly wage of your employees as that is not allowed in terms of our labour laws. Nor is it moral when you can make other plans. What you can do is reduce the labour time it takes to produce Widget A. Do this by improving the factory layout, better tools which reduce work time and better machinery like the Calibre5000.
- Reduce electricity usage by implementing better monitoring systems or automatic on/off lights. Implement smarter water heating systems. Reduce insurance costs on machinery by getting competitive quotes.
There are a million things you can do to improve the costs. You know your business better than anyone ever will so start thinking about what you can do.
Good luck with this week and enjoy the exercise. It’s really eye-opening when you start digging into this.
Next week we start with Marketing.