Control Your Profits By Controlling Your Costs
Every tennis specialty shop has a best customer. In fact, studies have shown that 80 percent of the income of most businesses usually comes from only 20 percent of its customers. But how can any tennis shop or facility owner, teaching pro, racquet stringer, or manufacturer tell whether that best customer is generating a fair share of bottom-line profits? Could your best customer actually be costing you money?
Only a few shop owners or managers actually utilize cost accounting or make an organized effort to control costs in their businesses, and, surprisingly, many who don’t are still quite successful. But are they as successful as they could be?
A retailer may “mark up” the goods sold by a fixed percentage that they label as “profit.” A court contractor may tack on a fixed amount to each job or service performed, while a manufacturer usually adds overhead costs to each job. Unfortunately, few tennis business operators seem to have any realistic basis for their “profit” additions. Knowing the cost of a product or service is the first step to setting profits.
There are, for example, a number of strategies that are useful for controlling the costs in your specialty shop or racquet sports business. And, best of all, not all of those strategies require large outlays of either time or salaries.
Cost accounting is the process of allocating all of the costs associated with generating a sale or performing a service, both direct and indirect. Direct costs include any materials, direct labor (the total wages paid to the workers who actually perform the service), costs paid to others, etc. Indirect costs include all other costs associated with keeping the operation’s doors open for business.
In general, cost accounting includes methods for reorganizing, classifying, allocating, aggregating and reporting actual costs and, often, comparing them with standard costs. It can mean determining unit cost to make a product or render a service. Cost accounting is an integral part of establishing a selling price or fees and indispensable whenever any racquet sports business or professional attempts to reduce prices for a sale.
As profit margins have shrunk, many business owners and managers have begun to discover just how valuable cost accounting is as a tool in their business. By knowing the total costs associated with the performance of the services offered or the cost of goods and products sold, an operator can determine which are the most profitable. Thus, the efforts of the owner/manager and the business’s employees can be focused on those areas, rather than on ones that offer little or no bottom-line enhancement.
According to Small Store Survival, the Illinois Retail Merchants Association’s publication for independent store owners and managers, today’s economic climate has forced many retailers to look more closely at reducing costs simply in order to survive. But what are the costs in your business?
The financial accounting that so many owner/managers are accustomed to is mainly concerned with the historical aspects of external reporting, that is, providing financial information to parties such as the owners, investors, creditors and, of course, the government. To keep these financial statements uniform and to protect those outside parties from being misled, financial accounting is governed by general accepted accounting principles (GAAP). Cost accounting, on the other hand, is more concerned with actually
running the business and pricing its products, services and inventory.
IN THE BEGINNING
Before any owner/manager can determine whether cost-cutting will increase profits, more information about the business is needed. Proper recordkeeping is the start. After all, business records provide the financial data needed to prepare a budget, profit and loss statements, break-even calculations, and operating ratios.
Whether prepared by an accountant or the result of a computerized bookkeeping system, every owner/manager should already have access to the financial statements of their business. Those financial statements can be used to control the costs of the business. That’s right, those basic financial statements provide a wealth of information that will help everyone to better understand both the direct and indirect costs of the racquet sports operation.
The majority of profit and loss statements show the various expenses for one accounting period as well as a percentage figure. It is not at all difficult to see that if utilities represented 2 percent of expenses last month and 9 percent this month, that something more than someone leaving a light on is happening and needs attention.
As mentioned, few tennis specialty shop retailers are aware of what their true costs of operating are or where those costs occur in the business. In fact, very few business owners/managers can answer the question: “How much does it cost you to turn the lights on?”
A good start involves identifying the areas in your business on which you and/or your employees spend time and money. While you may feel that you don’t need to justify spending either that time or money, chances are you’ve blind-sided yourself to lost profits.
It doesn’t take a cost-accounting system to reveal that customers can vary greatly in the demands that they make on the business’s resources. Traditional costing systems usually put support costs into a pool that is distributed across the operation’s cost centers, a procedure that many experts say can distort the true cost of performing a service or producing a product.
CONSIDER THE ALTERNATIVES
The reduction of specific fixed and variable expenses can improve the profit picture of any business. But beware: No one should cut costs needlessly. Legitimate expenses provide the framework for the business. No business should cut their operating budget too deeply because it might adversely affect the overall operation of the business.
Thus, along with cutting costs, every owner/manager should also consider the alternatives. Every business can reduce costs without cutting specific expenses. All that is required is to increase the average income per sale, per customer, per cost center, etc.
By increasing the overall value of a sale to each customer, for instance, the business spreads the same expenses across a large income. The result is a better sales vs. expense ratio.
Cost accounting is merely a tool. Although not every retailer or business owner will use it, those who do will find that it can help identify areas where costs may be higher or rising at a rapid rate. That tool shows an owner how expenses are distributed from year to year while identifying areas that should be reviewed.
Most importantly, cost accounting can provide the answers to a number of questions, such as:
- Can you negotiate a better lease?
- Can you renegotiate long-term debt at a better rate?
- Can you earn discounts by meeting accounts payable deadlines earlier in the payment cycle?
- Can you cut specific costs for specific time frames in order to reduce overall expenses?
And, of course, the biggest question that cost accounting can answer is: “How much does it cost simply to open the doors for business?”
Use Your Budget to Control Costs
Your budget should be a vibrant document, one that is understood and that is used on an ongoing basis. While it is part of a historical reporting system, it should not be used only to see how you’ve measured up to your goals months or even weeks after an accounting period has closed. Rather, this important information should be checked far more frequently.
When you created the basic chart of accounts for your business, you created a list of general categories such as office expense or repairs and maintenance. For the purpose of a profit and loss statement, those categories are all that are required. For the purpose of cost control, however, breaking down these items into subcategories might be warranted.
For example, you may find it useful to break down “Utilities” into its component parts: gas, electric, water, sewage. “Office Expenses” can be broken into supplies, equipment leases, postage, temporary help. And “Insurance” can be broken down to liability, auto, health, life, workers’ comp.
This will give you detailed information on exactly where the money is being spent so you can monitor and correct any serious excesses. Comparing your fixed expense to the budget and the amount spent a year earlier on the same item is a good way to see if you are still in line, and still controlling costs.
Even when the trend is exactly where you want it to be, you should not give up the habit of monitoring your business’s costs against budget. You can create a statement that looks like this one:
|COST OF SALES|
Thus, if you had anticipated income of $600,000 for 2004 and your income for January was $42,000, the INCOME line would read:
|INCOME||$ 50,000||$ 42,000||$ 42,000||($8,000)|
Thus, you will know at a glance whether you are over or under in any budget category. You can then research the line items if necessary to identify and correct any problems.
A healthy racquet sports business can bring a good return, long-term, to a prudent owner. Don’t make the mistake of choosing short-term satisfaction — or profit — at the risk of long-term stability. By knowing the costs in your business, you can not only ensure profitability but know what expenditures your business can actually afford.
See all articles by Mark E. Battersby
About the Author
Mark E. Battersby is a tax advisor and author in Ardmore, Pa.
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