Evaluate your Operating Expenses
10 MIN READ
How to Evaluate your Operating Expenses
The Profit First method evaluates your operating expenses and uses your existing revenue to generate a profit.
The foundation of this comes from the idea of flipping the formula because traditional accounting is failing small businesses.
When you think of the accounting formula, you think of Sales – Expenses = Profits. This formula makes your profits an afterthought or a by-product of running your business. Thus, putting all your focus on generating and spending money and very little focus on the profitability in the business.
But in Profit First, the formula is flipped to become: Sales – Profit = Expenses. So, instead of profit being the by-product of running your business it becomes the thing you are focused on achieving. Instead, your expenses are what must live within the by-product of the formula.
By changing your focus to retaining more money in your business, you become more critical of your spending. Enabling you to become more innovative in the ways in which your business functions. All of which creates increased profitability in your business.
Evaluating your operating expenses on a regular basis is the fastest way to increase your profitability. In addition, you can constantly ensure that your operating expenses are adding value to your business and cut the rest. By cutting the least valuable items, you can immediately see increased profitability.
A financially healthy company is a result of a frugal business owner not a cheap one.
What are Operating Expenses?
Let’s start by looking at operating expenses and determining what they are and how we use them. Operating expenses are those required for your business’s day-to-day maintenance and administration.
While many business owners can quickly identify the direct costs of running their business, operating expenses also include things like:
- Bonuses paid based on staff performance during a particular campaign
- Maintenance and Repairs costs for equipment and office space
- Office supplies; a few pens here and there may seem small, but the costs will add up over time
- Interest Expenses on business loans
- Dues & subscriptions for tools used in your business
So, when evaluating your business’s operating expenses, don’t just look at the direct costs of delivering your service, but think of everything you need to open your business’ doors.
Tracking and knowing your operating costs is important because it allows you to improve your profitability from within your business. The impact can be seen faster than working to grow your sales.
“A year from now, you will be glad you started today.”
Evaluating Your Operating Expenses
As a business owner, you should always look for ways to manage your operating expenses without sacrificing productivity.
It is essential to remember that you can’t simply start hacking away at expenses and cutting costs while hoping for the best.
Cutting too many expenses at once, or worse, cutting the wrong costs, can have detrimental effects on a business of any size. Still, small businesses are particularly vulnerable to this type of cost slashing.
So, what are the best ways to start managing and evaluating your operating expenses? Here are a few ideas that can help assess your business’s operating costs and enable you to reduce expenditures and become more profitable.
Know your numbers. Having a complete list of expenses is imperative, and I mean everything. Big or small, you need to know what you are spending, whether it’s rent, insurance, supplies, or the morning coffee filters. It would be best if you saw every penny your practice is spending. In this case, the general rule of thumb is that if your business is paying for it, you need to know about it.
It is also essential to make sure you are gathering every expense. As the world transitions to a subscription-based model, it can be easy to overlook the yearly fee for something you bought 11 months ago when pulling your expenses. That is why gathering at least the last 12 months of records is essential.
Another great way to gather expenses is to pull the list of vendors from your accounting system and document what purchases you have made from each of the vendors. Doing this helps ensure that you don’t overlook any expenses.
Take a look at your accounting system. If you don’t see any vendors next to your expenses, it’s time to start adding them. Vendors are a great way to ensure you are recording everything for which you are spending money. It is easier to remember expenses when you have a list of vendors.
Be very critical. Start by going through that list with a fine-tooth comb and question everything. What is this, why do we have it, what does it do, how does it help us achieve our goals, how does it support higher productivity, and how often do we use it? Write the answers down next to each expense.
Prioritize. Review your list from step two and prioritize the expenses using the following priority levels.
- Mission Critical: these are expenses that, no matter what must be paid, like rent and insurance
Promotes productivity: these expenses increase productivity in your business and allow you to get more done in less time.
Nice to Have: these expenses add to the experience or ambiance of your business. But, they aren’t critical to running the business.
Find a more valuable option: these are expenses you have in your business that you need, but they are just not bringing the value you need. You will need to research and find a better option to support your goals.
Cut Immediately: These expenses need to go right now because you aren’t using them, or they are not delivering value to your business.
Unclassified/Need More info: You should never have expenses you don’t know about, but it happens. Follow up as quickly as possible to determine these expenses and reclassify them.
Cut low-hanging fruit and instantly boost your profitability. First, sum up your expense total, start at the top, and keep adding until you get to the end. What is that total? How much are you spending on your business?
As we said earlier, you don’t want to start hacking away at expenses so start by cutting off the dead weight—things toward the bottom of the list that you could do without. Cut the last 10-line items, for example, and see your progress. You may realize that you can cut your expenses by 1-6% without feeling any effect whatsoever.
Take control of your business finances
Please don’t fall victim to repetition; you end up paying expenses because they exist without real analysis of why you are paying for them. Instead, plan to review your costs quarterly along with your Progress Assessment and re-evaluate your financial goals accordingly.
Profit First has you pay all your bills regularly, on the 10th and 25th of each month. Doing this allows you to see immediately any discrepancy from the bills you have to pay to the balance of your operating expense – More on this great Profit First technique coming your way later in the series.
The next step is gathering a complete list of your expenses so you can initiate a detailed review of your business spending money.
Next week we will continue discussing how you will evaluate your expenses and determine which ones to keep and which to cut.
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