Small businesses often work on tight margins, which leaves entrepreneurs and owners in search of ways to grow revenue and sustain a healthy profit. Profit margin is a mathematical equation that depends on two factors: revenue and expense. To achieve higher margins, you must increase revenue or reduce expenses.
Increasing cash flow without overloading employees or sacrificing product or service quality is a challenge, especially if your finances are tight and your resources are limited. Streamlining expenses is more straightforward and directly impacts your profit margin.
Cutting business costs can boost profitability. Implementing systematic cost-control methods can yield immediate savings while ensuring competitive profit margins.
How to reduce operational costs for your small business
Several small business functions and categories lend themselves to cost-cutting measures:
- Technology investments
- Outsourcing secondary business functions
- Hiring
- Negotiating with vendors
- Monitoring and adjusting business functions
We'll examine each element in more depth and point out ways to cut costs and boost profitability.
1. Embrace technology.
Examine current administrative processes and identify areas where automation and technology could relieve employees of manual tasks. Business technology is changing rapidly, and implementing the latest software and solutions can significantly reduce operational costs.
Many online solutions can automate various small business functions at a fraction of the cost of employing human resources. By automating repetitive tasks, you can save hours of manual effort every day, freeing employees to put their time toward business productivity. Additionally, since machines are not prone to mistakes, technology reduces human errors.
Here are a few ways you can reduce your operational costs with technology:
- Reduce your payroll burden. Instead of hiring a bookkeeper and staffing a billing department, incorporate invoicing and accounting software to improve efficiency. Accounting solutions can significantly reduce the time needed to accomplish daily tasks, freeing team members to pursue other crucial business pursuits.
- Lower your marketing costs. Experiment with low-cost marketing methods and platforms. For example, explore Facebook marketing tools, use Instagram for business, and try Pinterest ads to reach your target market directly. Google Ads is another way to put your business in front of people actively searching for your products or services.
- Pay less for office space. One lesson from the COVID-19 pandemic is that office space isn't always necessary. In fact, the Survey of Business Uncertainty by the Federal Reserve Bank of Atlanta found that the share of work-from-home days is expected to nearly triple from pre-pandemic levels, up from 5.5% to 16.6% in the post-pandemic era. With an expanded remote workforce, consider downsizing or eliminating office space. Technologies like Google Drive or Basecamp centralize documents and file storage, while Skype, Slack, Trello and Zoom enable virtual meetings and collaboration.
- Save on travel expenses. Commuting costs and travel allowances comprise a significant percentage of a business's total operational expenses. Save money and time by organizing meetings and presentations online instead. Webex by Cisco can be an excellent utility to conduct meetings, webinars, and presentations online.
2. Outsource business functions.
Finding an outsourcing partner for secondary business functions is another smart way to reduce operational costs. Outsourcing helps keep your organization slim while lowering payroll costs. Instead of diverting your focus and effort to manage nonessential tasks, you'll be able to devote your time to revenue-generating activities.
Here are some services that may lend themselves to successful outsourcing.
- IT support activities: If you only have a handful of computer systems to manage, you don't necessarily need an in-house team of hardware specialists. Computers don't crash every other day, but when they do, a service center in your area can help. Besides fixing your computers, an outsourced IT provider can offer several valuable services, including software installation, troubleshooting for performance issues, and routine system maintenance.
- Tax preparation: Preparing your annual tax return is one area where you don't need dedicated employees throughout the year. Modern accounting programs can do much of the legwork to prepare for tax filing, and then you can send records and reports to an outside tax professional.
- Customer support: Every business deals with customers, and customer support is an area no one can afford to ignore. But maintaining a customer support team can be costly, especially when you take recruitment and training expenses into consideration. Many small businesses prefer to outsource customer service activities to an external vendor rather than handle it in-house.
- Marketing: You may want to hire an outside marketing firm to handle your advertising, social media marketing and other marketing avenues. Hiring an experienced in-house marketing executive can be expensive, and with so many marketing channels, choosing what to focus on can be confusing. Consider interviewing marketing agencies so you can tap into their experience and expertise to help grow your company. Agencies will usually provide a proposal with recommendations and budgets, helping you select the right outsourced marketing partner for your needs.
3. Make smarter hiring decisions.
Reduce yearly HR expenditures with smart hiring decisions, such as finding applicants with multiple skills. For example, if your new administrative assistant understands content marketing, that's a huge plus.
Another idea is to hire contractors instead of full-time employees. Many small businesses are turning to exceptional professional freelancers for ad hoc jobs. This practice has revolutionized the way startups compete with established organizations in today's marketplace.
Hiring freelancers and interns can be a money-saving masterstroke for small businesses. Hire contract professionals for as long as it takes to get the job done; you don't need to pay them when there's no work. The work gets done, and the overhead isn't added to your payroll commitments. It's a win-win situation.
Here are a few areas where businesses often benefit from hiring freelancers.
- Copywriting: Need a copywriter to create engaging content for your new website, or to draft your weekly newsletters or blog posts? If so, browse freelance marketplaces like Upwork or Guru to find tons of talented copywriters at a fraction of the cost of full-time employees. Freelance copywriters usually charge an hourly or per-word rate. According to Upwork, copywriters charge $19 to $45 per hour, but rates can be higher depending on various factors, including amount of research needed, content specialization, project type and complexity, expertise level, and tight deadlines.
- Web development: You could employ a freelance web developer to build your business website. Using a freelancer is less expensive than appointing a full-time web developer or using one of the best website builders and design services. Because the work is mostly coding, some small businesses use web developers based overseas, since they tend to charge lower rates. If your website is relatively simple, you could use a web template service like Wix to create your own site.
- Search engine optimization: Organic visitors are the driving force behind any online business's success. While large-scale businesses have the budget to build an in-house team of SEO experts, startups may have a difficult time employing a full-time SEO professional. Freelance services can help. A freelance SEO contractor can optimize your website code and incorporate keywords, among other tasks. You can pay them a monthly charge to fix issues and submit listings to keep your site visible.
- Graphic design: Need a quick flyer designed? Looking for a graphic artist to create the landing page template for a new email marketing campaign? For ad hoc design tasks, a freelance graphic designer fits the bill. Sites like Fiverr and 99designs are your best bet to find an awesome graphic designer for as low as $5 per task.
4. Negotiate with vendors.
Are you paying the best possible prices for goods and services? Examine your operating expenses and see where you may be able to negotiate better rates. Consider the following factors.
- Volume discounts: If you buy products or raw materials in bulk, you may be able to get a volume discount.
- Good-customer flexibility: Leverage the fact that your business has been the vendor's customer for a long time, has an excellent payment history, or makes frequent high-cost orders. The vendor won't want to lose you as a customer and may be flexible on price.
- Major-customer status: Does your company account for at least 10% of the vendor's annual revenue? If so, you are in a good negotiating position and should be able to bring down the price.
- Competitors' prices: Look at what competing vendors charge for the same service or materials, and use this information to negotiate. If the vendor doesn't budge on price, you can always switch vendors.
- Reviews or testimonials: Offer to give the vendor a positive review or testimonial for marketing purposes. The vendor might show its appreciation with lower prices.
- Non-price concessions: Even if you can't lower the overall price, you may be able to win other contract term changes, such as better payment terms or faster delivery.
5. Continually analyze and adjust.
Running a successful business is an ongoing process that necessitates continuous monitoring, analysis and adjustment. Examine several cost factors to ensure you aren't paying more than is absolutely necessary.
Here are some examples of areas to monitor for potential cost-cutting opportunities.
- Employee time: Are certain times of the day, week, month or year busier than others? If you have hourly employees, schedule more of them during busier periods and fewer during slow times. To maximize employee time, if you have a POS system, view POS sales reports by time of day, week, and month. The best credit card processors also have dashboards that allow you to view various sales reports. When you stay on top of your staffing needs, you ensure coverage while saving money.
- Inventory levels: Storing inventory can be expensive, especially when renting warehouse space. In your inventory management software or POS system's inventory features, examine sales reports by time period and product to determine optimal inventory levels. Drill down to product specifics, as one size, version or color may sell better than others. Alternatively, implement a just-in-time strategy for inventory to minimize costs; for e-commerce orders, consider dropshipping directly from the supplier.
- Finance costs: While financial costs aren't as variable as personnel or inventory costs, conduct a review of your financial expenses every quarter. Are you getting the most interest on the money you have in the bank? Should you refinance an outstanding business loan at a lower rate? Should you renegotiate your credit card processing fees? A periodic review will ensure your financial vendors aren't taking advantage of you.
What are operational costs?
Operational costs are the day-to-day expenses you pay to run your business, such as the following:
- Cost of goods sold (COGS) – the amount it takes to buy or make, package, and sell your product (service businesses typically have no or very low COGS)
- Rent, equipment lease payments and utilities
- Phone and internet service
- Insurance
- Marketing expenses, such as advertising, trade show fees and graphic design
- Sales expenses, including travel
- Payroll and other HR expenses
- Office expenses
- Credit card processing and other bank fees
On financial statements, the cost of goods sold is subtracted from total revenue to get gross profit. Then, other operational costs are subtracted from the gross profit to get the net profit. This is the amount left over to be distributed to the business owners or reinvested.
Reducing overhead
Reducing operational costs is a proven practice to gain better margins. But to do that effectively, you must identify the areas where it is feasible to reduce overhead. Consider involving customers and suppliers to evaluate possible areas of improvement. Proper assessment of your profit and loss statement is equally important, as you don't want to take any undue risks that can harm your business's performance.
Remember that there is no one-size-fits-all approach to cutting costs and improving profitability. Something that works for another business might not work for you. However, a business with streamlined operating expenses is in better shape to push for improved margins, so make sure you're running a tight ship.
Jack Danielson contributed to the writing and research in this article.