This is a pretty familiar scenario. I’ve heard small business owners say it and I’ve heard Fortune 500 CEOs say it and I don’t see the logic in it. “Due to lower revenue/sales, we are taking measures to reduce costs.” Huh?
A lot of finance people will say that the companies in this position must get their expenses below their income in order to get profitable again and survive. That’s not entirely inaccurate. It’s just backwards. They need to get their income back up above their expenses. This is not to say that some reduction of expenses might not be in order, but the emphasis must be on reverting revenue back to its previous range.
Let’s look at this with some example numbers. The numbers are intentionally kept small (maybe unrealistically so but the the principle they illustrate is correct). Let’s say a small business owner was routinely making $5000 per month in revenue. Let’s say payroll is $1500 per month. Rent is $1250 per month. Phones, supplies and other necessary operating expenses are $1100 per month. Marketing/Advertising expenses are $700 per month. Profits are about $450 per month. There’s not a lot of wiggle room here.
Now if the revenues slump down to $4000 per month for a few months, this business is in trouble. The $50 per month in profit is gone and it’s in the red by $550 per month. If you go the economy route, you have to cut either payroll, marketing/advertising or other business expenses. Assuming this business’ employees are productive, cutting payroll either means less production or that the owner is going to be overloaded and will have to put in much longer hours. Cutting marketing and advertising will almost certainly depress revenue further so that doesn’t seem to smart. Cutting other necessary expenses means only that those things will eventually come up as financial stresses on the business. By definition “necessary” means that it is needed. It’s not a luxury or a frivolous expense. Now here’s the problem with trying to economize your way out of this slump: it could get worse
Another slump: Let’s say the business owner in my hypothetical company managed to get “profitable” by cutting payroll and is now working with $4000 per month in revenue and $3800 per month in expenses. He picked up the slack of the person(s) who were let go and is working longer hours, say 55 hours per week. Now 8 months later, revenue slumps from $4000 to $3500 and does not come up. The owner could extend his hours from 55 per week to 80 and let someone else go in order to regain profitability. Alright, let’s try that. There are no more employees. The owner’s working 80 hours per week, which is roughly 12 hours per day every day of the week. No time for himself or his family.
If revenues slump below expenses again, he doesn’t have much more room for cuts. In fact, chances are that if this business owners is working 80 hours per week with no staff, he’s not getting as much done as he did when he had his whole staff. This means production is falling behind. This alone can hurt business and trigger another decline of revenue. No matter the cause, let’s say revenues fall again. He’s now got to cut rent, or advertising or some other vital expense in order to get “profitable” again. Hmmm. OK. He finds a cheaper location for his business and moves it. The location isn’t as good as his original one but the rent savings are sufficient to get him back into the black.
Unfortunately, the lesser location resulted in loss of customers and revenues slump again. Advertising is cut. I’m sure you can see that eventually this guy is out of business.
Now let’s rewind to the first slump. Revenue was $5000 per month and dropped 20% to $4000 per month. Something changed. The exact cause of the slump needs to be isolated. It could have been a change in marketing, a change in delivery of the product or service, etc. What if the business owner can’t figure out the cause of the problem? That’s possible. There is still something that can be done. Review past marketing and advertising actions and figure out which of those was most successful. Repeat that with higher volume without reducing current marketing actions. In other words spend a little more on advertising actions in order to get those revenues reverted. This might require communicating with the landlord or vendors to buy yourself time paying them while your advertising is gotten out and is given some time to bite. If it worked before it will work again. Belt tightening can occur once the promotional actions are taken care of.
If promotion is considered the first priority and then any needed economizing is done. The business has a chance to pull out of it and maybe even grow. However, if the only thoughts are to economize and some how make due with less money, then the business will continue to shrink and will eventually cease to exist.