When looking at documents like the balance sheet and income statement, you may come across accounting terms that you’re unfamiliar with. Because these terms relate to your company’s financial health, understanding them is vital.
One term that’s incredibly relevant to business owners is “operating costs.” We’ll provide you with a concise overview of operating expenses. From there we’ll outline 14 things you can do to lower costs and increase your bottom line.
Operating costs are any expenses that are required for the day-to-day maintenance and administration of your business.
One of the primary components of operating costs is the cost of goods sold (COGS). COGS are the direct costs related to producing your business’s goods or services. Operating expenses also include things like:
Below are the two most important data points that you can obtain through operating costs, your operating income and operating expense ratio.
Operating income is the total profit associated with your company’s operations. The formula to calculate operating income is:
Operating Income = Total Revenues – Operating Costs
Example: So imagine that a company earned $552,000 in revenue last year and has $100,000 in operational expenses. The operating income for the year would be $452,000.
The operating expense ratio, on the other hand, does indicate financial health. By measuring efficiency as a percentage, it’s easier to compare yourself to others in your industry, no matter how big or small your business is.
Operating expense ratios (OER) give you a direct comparison of your expenses to your income, allowing you to track your efficiency. The equation for OER is:
Operating Expense Ratio = Operating Costs ÷ Total Revenues
Based on our example above, we would come up with:
OER = $100,000 ÷ $552,000 = .1812 × 100 = 18.12%
Operating expense ratios can vary by industry.
You should pay closer attention to how you rank within your industry. If you find ways to meet or beat the industry average, that can be a great indicator of success.
Improving your operating costs means putting yourself ahead of your competition. Small business owners should always be looking for ways to reduce their expenses without sacrificing the quality of their product or service.
What are the best ways to reduce your company’s operating costs? See 14 ideas that can help you reduce the operating costs of your business and potentially generate more revenue:
We’ll cover each of these tips in-depth below.
There are dozens of online systems and software programs that can automate and streamline the day-to-day functions of a small business. These systems can cover a variety of tasks, including accounting, website hosting, marketing communications, payroll, and more.
Technology is useful because it promotes efficiency. The result of efficiency is a reduction in operating costs in areas such as direct labor. Robots and computer programs can perform work faster than humans, and with fewer errors. Technology can improve supply chain processes as well, finding solutions for things like reducing the cost of shipping raw materials.
To choose the right program or service for you, ask yourself the following questions:
Answers to these questions will give you a clear indication of which aspects of your business you should automate with software.
If automation isn’t an option, hiring an outside specialist to perform work for you is another option to help improve efficiency. For example, one area that seems to especially benefit from outsourcing is advertising and marketing.
For many entrepreneurs, running an in-house marketing campaign is a distraction from their core business. While they find the amount of time they spend on advertising and marketing has a good return on investment, they would rather delegate it to someone else than manage it alone.
While it might seem like hiring an outside vendor would cost more than doing it yourself, in the long run, delegating specific tasks to subject matter experts will save you money and generate even better results. Outsourcing certain operations is an investment that pays dividends over time.
Outsourcing your human resource needs or IT department is one thing, but what about tasks that need to be completed infrequently? Freelancers can fill the gap for roles in your business that aren’t needed all the time.
For infrequent on-demand needs, having a full-time employee doesn’t make sense:
They increase your operating costs through insurance, paid time off, and payroll taxes. Businesses that need to scale up or scale down rapidly can take advantage of the growing pool of freelance workers available to work on a per-project basis while keeping costs down.
There are plenty of online marketplaces that allow you to browse and hire freelancers from all over the world. Though, keep in mind that with freelancers, cheap isn’t always the best option. You’ll save money over time by paying someone more for higher quality work rather than paying a cheaper freelancer that continually disappoints.
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Interns are a great way to lower costs. Interns are new to the job market and have a limited work history. They take on internships to gain real-world professional experience and learn valuable business skills.
Your business benefits as well, because interns are paid less than a regular employee and have reduced employee benefits. In the intern/business relationship, everyone benefits. Internships also reduce recruitment costs.
After an intern has proven they’re an asset to your organization, you can hire them without having to spend money searching for a qualified candidate. Because you already know this person and understand their abilities, there’s likely no need for an interview process or even training.
If you work with vendors regularly, you might want to set up a bidding system for projects and work. If you ask three different vendors to provide quotes, you can have them compete to see who is willing to provide the work for you at the cheapest price.
Be sure to compile an accurate scope of work or request for proposal (RFP) for vendors to bid on, as missing information or added complexity can significantly affect the quoted rate. Having an accurate quote can allow you to better plan for anticipated operating expenses.
Leasing office space, paying your utility bills, and managing a physical workspace can be a drain on your financial resources. Thousands of companies have opted to get rid of their office space and work completely remote. Allowing staff to work from home allows businesses to reduce their physical footprint and lower operating costs.
Telecommuting is on the rise across the United States. In 2005, only 1.8 million U.S. employees said that they telecommuted for half the week. In 2015, that number had grown to 3.9 million. Upwork estimates that by 2025, more than 36 million Americans will work from home.
With the amount of connectivity available today, the difference between an employee working two cubicles away or working two states away is almost indiscernible. Employees will typically also find working from home advantageous, as they don’t have to spend time and money commuting to the office each day.
Many vendors will offer a discount if you pay your invoice early. Even a savings of 2%–3% per billing cycle can really add up. Let’s say your annual operating costs are $100,000. If you take advantage of paying invoices early and save 2%, you would end up cutting your costs by $2,000 a year.
At the very least, make sure to pay your invoices on time to avoid any late fees or other penalties. The same goes for loans or any other debt you’ve taken out. Your interest expenses can increase if you’re late or begin to miss payments.
You should always be looking for ways to make your business more efficient. By tightening up your processes and procedures, you can reduce waste in both materials and time. If you run a bakery, for example, and find yourself throwing out dozens of bagels and donuts every night, adjust your baking process to reduce all of that waste.
Again, you can consider this an investment in your company. A small reward to an employee could end up saving you thousands of dollars down the line.
Sometimes a subscription service just isn’t as useful as we thought it would be. Companies make millions of dollars a year with software-as-a-service apps that companies sign up for, but never get around to using.
It’s easy to lose track of unused services, especially if you’ve set them up for recurring payments via auto-pay on your credit card. If you do find a service that you like but don’t use all of the features, try shopping around to see if there are cheaper alternatives available.
Auditing small recurring costs isn’t a one-time task. It should be done regularly to cut costs and keep your organization lean. Set up a quarterly or biannual reminder to check for unneeded services that you can get rid of.
Many apps follow the “freemium” model—you can use the base model of the program for free, but you have to pay to get access to additional features. But sometimes, those more sophisticated features never get used, and the company has wasted operational expenses for nothing.
Have your team try out the free version of an app and see how well it suits their needs. If it becomes indispensable, there may be plans available that make it more cost effective.
Another way to save money is to go paperless. Have you ever walked by the office printer to find 25 copies of a document that someone accidentally printed out and then left behind? Do you really need to print a dozen color copies of the annual report for a meeting where everyone can see the report on a giant screen anyway?
Like typewriters, landlines, and fax machines, the office printer is quickly becoming a relic from a bygone era of business. Business owners still oftentimes ignore printing costs, however, because they consider them unavoidable.
Printing everything from internal documents to catalogs and flyers increases your company’s operating expenses. Encourage employees to print out documents only when absolutely necessary, and if you have to print an expensive glossy catalog, order a batch small enough that there won’t be any sitting in the recycling bin.
In addition to a paper-free business, there are many other ways to make a positive impact on your budget and the environment. If you have an office space, consider making it as green as possible.
To reduce energy usage, replace regular light bulbs with compact fluorescent lighting, look to lower heating and cooling costs by improving your insulation and windows, and cut back on the amount of physical waste. If you have several workstations that are unused, unplug the devices in it to reduce electricity consumption. Not only will you save on utility costs, you’ll save on your monthly office supply costs as well.
An often overlooked way to reduce business overhead is to barter. After all, why pay cash for something when you can trade for it? Take a look at the businesses you already work with and see if there’s a product or service you offer that you could trade for.
If you’re already contracted with a carpet cleaning company, ask them if they’d like you to manage their marketing in exchange for monthly cleanings. If there’s a great food truck in your neighborhood and your company prints uniforms, ask the owner if you can print up a set of new uniforms for their staff in exchange for catered lunches.
There are a lot of creative ways you can trade your services to get the things your business needs without having to spend any extra money.
Many businesses have already drastically reduced their business travel, and that trend may become more popular in the near future. The widespread adoption of video conferencing has shown that business can be conducted around the globe without ever having to set foot onto an airplane.
Hotel costs, delayed flights, missed connections, along with rescheduling fees can add up quickly, making that in-person sales pitch all the more costly. While you can often write off travel expenses, there are many that you can’t write off.
Take a hard look at your business travel budget and decide which trips need to be done face-to-face and which can be done virtually. Reducing travel lowers your operational expenses and is better for the environment, too.
Are you the type of owner who merely monitors business expenses and income without looking at detailed breakdowns? If so, it’s time to change that. As your business grows, understanding the intricacies of things like your operating costs will become increasingly important.
Operating costs allow you to take an in-depth look at how your expenses impact your profits. QuickBooks small business accounting software makes it easy for you to identify and correct areas of waste in your company so you can improve your financial health. Every dollar you save on operational expenses is a dollar you can reinvest into your business.
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