What is expense analysis? A hidden goldmine that impacts your bottom line

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Performing an expense analysis involves breaking down and categorizing expenses to understand where money is being spent and to identify areas where costs can be controlled or reduced. It’s a critical aspect of financial management, and it can help you and your business make informed decisions about resource allocation, budgeting, and strategic planning.

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In this article, we’ll give you the step-by-step process for doing an expense analysis, and show you some ways you can automate the process. 

What is an expense analysis?

An expense analysis is the systematic examination and evaluation of the various costs and expenditures incurred by an organization over a specific period. The primary objective of expense analysis is to gain insights into how resources are being utilized, and identify areas of overspending or inefficiency. 

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The key components of an expense analysis include:

1. Data Collection: Gathering invoices, receipts, bills, and financial statements related to income and expenses.
2. Categorization: Organizing expenses into different categories or classifications based on their nature and purpose. 
3. Comparison: Comparing current expenses to historical data from previous periods to assess performance and identify trends. 
4. Variance Analysis: Analyzing the differences (variances) between budgeted or expected expenses and actual expenses. 
5. Identification of Cost Drivers: Identifying the factors or activities that contribute most significantly to overall expenses within each expense category. 
6. Cost Optimization Opportunities: Identifying opportunities to reduce costs or improve cost efficiency. 
7. Reporting: Presenting an expense report containing the findings of the expense analysis in a clear and concise manner to stakeholders.

How to perform a line-by-line expense analysis

Performing a line-by-line income and expense analysis involves systematically reviewing each individual expense item to understand its nature, purpose, and impact on overall financial performance. 

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‍In the following steps, we’ll show you how to analyze major expense lines on the income statement. 

1. Product/service level COGS analysis

• Break down COGS by each product or service category.
• Calculate the percentage of total revenue represented by COGS for each category.
• Identify products or services with high or increasing COGS as a percentage of revenue.
• Benchmark the percentages with the industry.
• Assess where you stand as compared to the industry.some text
  • If percentages are higher than the industry average, explore avenues to reduce cost through vendor negotiations, searching for alternative suppliers, and eliminating waste.

2. Gross margin analysis

A Gross margin analysis can identify the percentage of COGS to the revenue generated for each product.

• Calculate the gross margin for the overall business and individual product lines.
• Analyze gross margin trends over time. Is it improving or deteriorating?
• If deteriorating, find out the root causes and address them. This might even lead to strategic decisions to discontinue a product(s).
• Identify the impact of changes in production costs, materials, or supplier relationships on gross margin.

3. Inventory management

• Analyze inventory turnover rates and carrying costs.
• Assess whether excess inventory or stockouts are impacting COGS.
• Optimize inventory levels to reduce carrying costs.
• Calculate days inventory outstanding (DIO) by measuring the average number of days it takes to sell inventory. A lower DIO indicates a faster inventory turnover.
• Implement techniques to reduce the inventory holding period. 

4. Production efficiency

• Evaluate production processes and efficiencies.
• Identify bottlenecks or areas where production can be streamlined to reduce costs.
• Monitor production waste and scrap rates.
• Use cost accounting methods to allocate costs to specific products or processes.
• Adopt lean manufacturing principles to eliminate waste and streamline processes.
• Identify and eliminate non-value-added activities that don't contribute to the final product.
• Implement robust quality control processes to minimize defects and rework. Address root causes of defects to prevent recurring issues and associated costs.

5. Fixed vs. variable expenses

• Analyze the behavior of variable business expenses in relation to revenue changes.
• Differentiate between fixed and variable expenses.
• Conduct a break-even analysis to determine the production level at which total revenue equals total costs. Identify the contribution margin (selling price minus variable cost per unit) to assess the profitability of each unit.
• Perform sensitivity analysis by assessing how changes in production levels impact fixed and variable costs. Identify the point at which certain costs become variable due to changes in production.
• Assess the flexibility of fixed expenses and explore opportunities for cost reduction. This can be achieved once a line-by-line expense analysis of other operating expenses (OPEX) is completed.

6. Employee productivity

• Evaluate metrics, such as revenue per employee or sales per employee.
• Assess the impact of changes in headcount on production or sales output and OPEX.
• Identify areas for workforce optimization or training.
• Assess the percentage of assigned tasks completed within the specified timeframe. Benchmark the results with the industry best practices to assess employee productivity and performance.
• Identify and track relevant key performance indicators (KPIs) that reflect employee performance. Examples include output per hour, sales targets, customer satisfaction scores, and error rates.
• Explore outsourcing options. Outsourcing certain functions can increase efficiency and reduce cost. 

7. Expense category breakdown

• Break down OPEX into various business expense categories (e.g., salaries, marketing, rent, utilities).
• Calculate the percentage of total revenue represented by each expense category.
• Identify expense categories with significant or increasing percentages.
• Compare actual expenses to budgeted or historical expenses. Analyze variances and understand the reasons behind them. Determine whether expenses are in line with expectations.

8. Marketing and advertising ROI

• Analyze marketing and advertising expenses to revenue generated.
• Calculate the return on investment (ROI) for marketing campaigns.
• Adjust marketing strategies based on cost-effectiveness.
• Clearly define the goals of your marketing and advertising campaigns, whether it's brand awareness, lead generation, sales, or customer retention.
• Establish specific KPIs aligned with your objectives (e.g., website visits, conversion rates, customer acquisition cost).
• Calculate ROI using the formula: ROI = (Net Profit / Cost of Campaign) x 100.

9. Lease and rental analysis

• Review lease agreements and rental contracts.
• Assess the cost of leasehold space and its impact on OPEX.
• Explore renegotiation options or location optimization.
• Create a comprehensive inventory of all leased assets, including real estate, equipment, and vehicles.
• Classify leases based on their importance and impact on business operations.
• Conduct a cost-benefit analysis for each lease to evaluate its contribution to business operations. Compare the benefits derived from leased assets against the associated costs.
• Evaluate using office and warehouse space to make sure it aligns with business needs.

10. Energy and utility efficiency

• Evaluate energy and utility consumption and costs.
• Identify energy-saving opportunities and cost-reduction initiatives.
• Implement sustainability practices to reduce environmental impact and costs.
• Perform energy audits or use energy management software to analyze usage patterns.
• Upgrade to energy-efficient lighting technologies (LEDs). Implement motion sensors and timers to control lighting usage.
• Plan and budget capital expenditure to replace outdated equipment at the end of useful life with Energy Star-rated or energy-efficient alternatives.
• Conduct a life-cycle cost analysis to evaluate cost-effectiveness.

11. Technology and IT expenses

• Assess the cost of technology infrastructure and IT services.
• Ensure technology investments align with business needs and provide a positive ROI.
• Explore opportunities for technology consolidation or optimization.
• Negotiate current recurring IT services contracts or explore options for cost-effective alternatives.
• Assess cost-benefit analysis of in-house server rooms versus third-party cloud services. 

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You may realize that you don’t need to perform all of these expense analyses monthly, and may in fact be able to carry them out bi-monthly, quarterly, or even annually. Much of this will depend on when you’re expected to present expense reports to your key stakeholders. 

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Also, you may find that by using technology, you can automate some, if not all, of these analyses. For instance, Ramp’s expense management software allows you to seamlessly automate invoice processing and expense management, and generate real-time expense reports. Plus, it allows for precise expense tracking. 

Why performing a regular expense analysis is important

While companies usually focus on revenue and top line, they often overlook managing and analyzing their expenses effectively. This becomes a problem when tough times hit, or unexpected events occur. Learning from experiences during the COVID-19 pandemic, it's clear that understanding and controlling expenses is imperative even when things are going well. That’s why performing a regular expense analysis is so important. 

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The following five-step plan provides a practical way for companies to optimize their costs. By carefully looking at different expense categories, businesses can optimize cost and work more efficiently. These steps are:

1. Line-by-line expense analysis
2. Investigate the root cause
3. Improve and implement processes
4. Leverage technology to automate/streamline processes
5. Continuous improvement by tracking the effectiveness of changes

Maximize your bottom line with Ramp's effortless expense management

Ramp revolutionizes the expense analysis process with its automated expense management software, integrated seamlessly with your corporate cards, reimbursements, invoices, and more. Ramp empowers your team to control spending proactively, with policies built into employee cards, and custom workflows for budget approvals. 

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Ramp's user-friendly platform eliminates traditional expense reports, automates receipt matching, and ensures compliance with real-time monitoring and AI-powered insights. Plus, accurate expense tracking so you can be prepared not only for expense analyses but for the end of the tax year. 

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By providing instant visibility into every transaction and uncovering cost-saving opportunities, Ramp transforms your expense management into a strategic tool for financial optimization and informed decision making.