How to reduce operational costs for your small business
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When you run a small business, every penny matters—especially in the early stages when budgets are tight. By reducing operational costs, not only do you streamline efficiencies for your business but you also increase your profit margins. This sets you up for long-term growth.
What are operational costs?
Generally speaking, operating costs are the expenses that keep the business running on a daily basis. This consists of a mixture of both fixed expenses and variable costs. The fixed costs remain steady, whereas variable costs can shift on a monthly basis.
In simple terms, operating costs are the capital funds you need in order to “keep the lights on”—everything that you spend via credit card, invoice, ACH, etc.
That said, it’s more than just your electricity bill and office supplies. Operational costs can include the rent for your office space, accounting fees, travel expenses, sales, marketing, etc. It’s important to note that operational costs are not the same thing as operating expenses.
Operating costs = operating expenses + costs of goods sold (COGS).
This represents both the costs of providing your product or services as well as the expenses that would crop up regardless of whether or not a sale was made. The difference between these two terms is worth knowing. Per the Small Business Chronicle:
“It may seem like operating costs and operating expenses should mean the same thing, but they don't. The total operating expenses refer to the specific costs after gross revenue is defined in the income statement...Failing to understand this distinction could lead to misreading reports and not having a true picture of your company's financial health.”
For example, a small software-as-a-service (SaaS) company’s operating costs can typically be broken down into four primary components:
1. Cost of Goods Sold
- Personnel costs for implementation (consulting, data migration, training)
- Direct materials
- Software delivery hosting expenses
- Costs for third-party software tied to the delivered product
- Customer support team personnel costs
2. Office related expenses
- Office equipment
- Accounting, Legal, and other professional services
3. Sales and marketing-related expenses
- Sales materials
- Travel & entertainment
- Direct mailing
4. Compensation-related expenses
- Payroll tax expenses
- Sales commissions
- Employee benefits
These expenses are broken out on the SaaS companies’ P&L statement: S&M (sales and marketing), R&D (research and development), and G&A (general and administrative).
How to reduce your operational costs
There are four cost reduction measures you can implement to reduce your small business operating costs and improve profitability.
1. Embrace technology
While running a business, there are dozens of concerns business owners and their teams need to juggle full-time, usually on a daily basis. Any tasks that are rote or manual (matching receipts to expenses, for example) can probably be better handled by computer apps. Automation and streamlining of small business processes drive connectivity and efficiency, especially when it supplants laborious and error-prone manual processes.
A question you should ask yourself is: “Are my employees optimally positioned to be performing tasks that only they can handle thanks to their training and expertise?”
Your goal should be to derive the most value possible from each employee. If they’re inundated with tasks like manual data entry, that’s likely a waste of their talents, since a computer can perform the action faster and with fewer errors. By removing inefficiencies and increasing the work capacity of each employee, you’ll reduce labor costs in the long run.
There are all sorts of areas of your business in which software programs could empower employees and optimize your operations. Take expense reporting for instance. For many companies, closing the books at the end of the month can be a wearisome process that takes several days to complete. This manual-based process creates several different labor and time costs:
- Time to fill out an expense report – 28 min
- Time for supervisors to review an expense report – 11 min
- Time for accounting team to process an expense report – 20 min
- Time to reimburse expense report and reconcile payment – 17 min
If you have five employees at your company, maybe this isn’t a big issue. What happens when you scale? What happens when five employees become 50 or 500?
Armed with the right software program, you can dramatically cut these numbers and optimize expense reporting. This small tweak will not only have a massive impact on both your bottom line but will also make life easier for everyone in your organization.
Switching from manual to digital expense reporting is just one example of how technology can help you reduce your operational costs. There’s also software that can discover duplicated and extraneous spend via SaaS creep, or technologies that can help you better manage your vendor relationship. Ideally, you want a software platform that performs all of this and more.
2. Change employee spending behavior
Old habits die hard. This is especially true when it comes to company spending habits.
Wasteful spending habits, maverick spending, and redundant spending adds up quickly, particularly when you multiply that across an entire organization—even a small one. While this may be a difficult problem to solve, it is fixable.
How can you change employee spending behavior?
For starters, it takes a company-wide ethos from the top down. Upper management must model the importance of being financially wise and prudent with spending behaviors. If a company’s higher ups aren’t careful about how they spend company money, how can you reasonably expect employees to care when they have even less skin in the game?
To begin making inroads, it’s critical that you have insights into your employee’s spending habits. This involves monitoring their company card spending on a monthly, if not weekly basis. By having real-time visibility over this spending, you can create more accountability with your employees.
If you have conversations and employee behavior doesn’t change, you may want to take greater control to limit their spending. Ideally, your corporate card should make it possible to track employee spending on a macro and micro level, as well as allow you to spin up as many cards as you want with specific limits or spending purposes in mind.
This ensures that the funds you’ve budgeted for can be allocated purposefully.
3. Negotiate contracts with vendors
Do you know whether you’re getting the best deal possible with your vendors?
Managing your deals with vendors can be difficult, especially if you’re managing them all from disparate places. To begin analyzing the costs of your vendor relationships, you should focus on two areas:
- Largest monthly expenditures – Cutting even a small percentage of these expenses can have a significant impact on overall cost savings. Sometimes, it may be better to create a bidding system for projects and work with different vendors. This forces them to bid down, which reduces your costs.
- Longest business relationship – You may be able to leverage long-standing relationships during vendor negotiations. If vendors value your business relationship, they may be willing to provide perks or discounts, better deals, or flexibility in times where you’re cash negative.
Once more, technology can help you reduce supply chain costs via predictive vendor management. A Control Center allows you to manage all your vendors in one place. From there, you can see how much vendors overall cost in real-time, who uses them, and when payments are due. It can also help you predict and control recurring expenses before they even happen and eliminate zombie spend.
By having this information readily available, it’s much easier to compare, contrast, and monitor your spending. Armed with this knowledge, you can have greater insights over which vendors are providing ROI and which ones are dispensable.
4. Reduce your overhead costs
Although they may often get bundled into the same category, overhead costs are not the same as operating costs. But, there is overlap between the two. By focusing on lowering your overhead costs, you can lower operating costs and improve your cash flow. This ensures that the business stays liquid and is capable of weathering most any financial storm.
Overhead costs are business expenses related to daily operations. But unlike operational expenses, overhead isn’t tied to a specific business activity or cost unit. Instead, it supports the business’ cost-generating operations. Examples include, rent, utilities, insurance, administrative & maintenance costs, etc. As Harvard Business Review notes, making cuts to this expansive category is easier said than done:
“Given the enormous diversity of overhead activities, it is easy to see why they are so hard to cut. Each of the many types of activity performed in support of a company’s line functions may include a variety of distinct skills or areas of expertise. Even subdisciplines within a single functional area may embrace diverse specialties.”
Although it depends on your financial situation, there are several areas of your business you can review to find cost savings, including:
- Renting or leasing a workspace instead of buying, or getting rid of an office space entirely in favor of telecommuting
- Ensuring that your spending is generating ROI
- Outsourcing your work to freelancers or hiring in-house part-time employees if it’s more cost-effective
- Going green by getting energy-efficient light bulbs and other equipment to lower utility costs
- Reviewing your contracts
Ramp: Strengthening your finances
When it comes to reducing your operational costs, there are several areas of your business that you need to consider. Wouldn’t it be great if you had a small business corporate card and expense management platform that could help you address each of these potential cost problems?
Enter Ramp. Ramp is a corporate card that can help you reduce your operational costs, monitor spending in real-time, control your expenses, and manage vendor relationships. In addition to high credit limits, instant 1.5% cash back on purchases, and unlimited virtual and physical cards, Ramp is the only card that comes with a built-in expense management platform.
On top of this, Ramp's software includes automated vendor management. Now, companies can save time and resources on vendor management by centralizing the SaaS procurement process, uncovering shadow IT, and eliminating duplicate spend.
With Ramp, you can reconcile instantly and view your company spend as it happens, all while cutting expenses. Put simply, it’s the key to reducing your small business’ operational costs.
See how Ramp can strengthen your finances today.