Reducing overheads is not everything!

By Peter cox October 21, 2016 Industry news

In my last article I said in my opening line that sales turnover is important and, for many outsiders, will be the key barometer of business success.

If turnover goes up then the assumption is that everything is great.

This is the reason why for nearly all supplier reps and stores the sole target is increasing turnover.

The perspective of many bean counters is quite often different however.

They may jump to the other side of the fence, prioritising instead a reduction in overheads. Trouble is, in some cases this may be at the same time as the operation’s budget requires an increased level of activity – that is sales.

 

TO TRIM OR NOT TO TRIM – FIXED OR VARIABLE?

Overheads fall into two categories: fixed; and variable.

Fixed overheads are those that are incurred regardless of the level of activity. Some which come into mind are rent, rates and depreciation.

In my view, unless specific strategies are planned such as reducing space or the amount of equipment required, fixed overheads should not be budgeted to be reduced.

Variable overheads are different and can be targeted for change. Examples are wages, power, phone, insurance and vehicle to name a few.

So – what are the dangers in strategising to improve the bottom line by cutting overheads?

 

CUTTING THE WAGE BUDGET HAS IMPLICATIONS

The first overhead normally looked at for savings is also the largest – wages.

But the repercussions of budgeting to reduce staff numbers and/or hours may well be that service levels drop.

And this may well lead to a reduction in the customer count, and this obviously knocks into sales turnover and add-on sales.

If wages are out of control they need to be brought under control. However simply cutting wages as a strategy does not make sense if the operation is budgeting for an increase in activity through an increase from sales and customer counts – it is illogical!

What’s more, a reduction in staff numbers or hours brings with it several other repercussions.

With less staff you may struggle to complete paperwork correctly and short cuts in your normally robust procedures could become evident, in particular goods inwards and booking out.

So what may on paper be a saving wages could well be offset by a loss in profitability through a lower Gross Profit Margin.

Put simply staff become stretched, overworked and may make mistakes.

 

BIG SALES INCREASE + OVERHEAD DROP = LESS PROFIT

By way of an example, let’s look at what happens when our old friend XYZ Hardware cuts their overheads by just 4%:

These figures show the effect of an increase in turnover at the same time as a reduction in overheads – that is, a reduction in Net Profit.

Sales have increased by 10%, overheads have reduced by 4% yet Net Profit has reduced by 8% – a dramatic reduction in margin.

 

TOP LINE GROWTH + OVERHEAD INCREASE = BOTTOM LINE GAIN

In my last article I examined why so many people simply concentrate on sales and will adopt any strategy to achieve the sales dollar target, even if that means discounting and thus reducing the Gross Profit Margin.

In this article I hope I have shown that by simply concentrating on reducing overheads has a detrimental effect on Gross Profit Margin.

So the key – and I have been banging the drum on this in this magazine for 25 years – is Gross Profit.

By targeting a 10% increase in turnover and no reduction in overheads, the following can be achieved.

There are more than 10 major factors that can increase Gross Profit Margin.

Some of these are better merchandising, add-on sales, good booking out procedures, minimising uncontrolled discounting, pricing margin management, reducing theft, checking all stock in and freight bills, checking prices and reducing damage stock.

It is all-important to have targets – and in particular Net Profit.

It is equally important to choose the right path to get you there!


 

Peter Cox is a senior consultant for Macquarie Advisory Partnership based in Sydney. He has over a decade of experience training and consulting in the retail hardware industry. He conducts key-note addresses, and management and sales workshops, which are aimed at improving profitability and liquidity in one of Australasia’s most competitive retail environments. Phone 0061 438 712 200 or visit www.petermcox.com.au

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