The outbreak of COVID-19 caught us all by surprise. Businesses had to act decisively and swiftly to adjust their budgets and cut expenses on the go for the sake of their survival.
With 2022 looming, it looks like the pandemic is going to stick around for the foreseeable future. But now that we have more knowledge of what we’re dealing with, we can plan ahead with our yearly expense budget in a more thorough manner. It is time to strike a balance between cutting expenses and keeping up with the key business initiatives required to hit the ground running when this is all over.
Here are some insights on the actions business owners should take to make the best out of their expense budget planning for 2022.
Take full stock of your expenses.
Have a full list of all current and expected expenses. It’s paramount that you have a comprehensive understanding of all your expenditures before deciding to cut any costs and that you categorize them properly into variable costs and fixed costs. Categorizing the costs will help you in making a more informed decision as to where to cut or scale down while minimizing any adverse effects on productivity.
Fixed (or overhead) costs are expenses that remain steady over time, irrespectively of the product or service. In other words, if you have to halt your activity for a while, you will still incur fixed costs. Such costs may include rent, certain utilities (phone, internet), insurance, and loans.
Variable costs are the expenses that correlate with the services or the goods that the business provides. Such costs may include production-related utilities (water, gas, electricity), cost of materials, and certain vendor payments.
Do a “worst-case/best-case” break-even analysis.
Before you even start thinking about cutting costs, you need to know your prospective break-even point (BEP) by performing a break-even analysis.
A break-even point is the sales balance point in which your total revenue equals your cost, which means – the point where you are not making any profits, but also not incurring any loss.
By calculating your break-even point in different scenarios, you will better understand where and how much to cut costs. It’s an effective tool for other financial business management decisions as well, such as product pricing.
The formula is quite straight-forward:
fixed cost/(price-variable cost)*=units sold
*Per unit sold
As you can see, the time you took to categorize your costs into variable and fixed costs did not go to waste. By putting the different numbers in the formula, you know how many units of product and at what price you will need to sell to reach your break-even point.
But equally important – by putting “worst/best case” scenario figures in the “units sold” part of the equation, you will gain insights into how much, and the type of cost, you will need to cut or reduce to break-even.
Know where to cut.
While it is commonly suggested that businesses dive into variable costs first when looking where to trim down, this approach overlooks the differences and sensitivities of businesses and industries. It will be more sensible to take into account the specific characteristics of your business when deciding where to put the emphasis while considering the following:
- Where do most of the costs lie? If the lion’s share of the expenses is in fixed costs, it’s perhaps better to invest your reduction efforts there, and vice versa.
- Fixed costs are often harder to reduce, as they consist of long-term, harder to reopen commitments, such as leases, insurance policies, et cetera. On the flip side, if you do manage to reduce your fixed costs, it has a more significant impact in terms of savings due to its across-the-board nature.
- Variable costs are more intrinsic to your revenue, and they are generally viewed as easier to cut. However, we recommend cautiousness when dealing with them since they often directly influence your service or product quality. If your business prides itself on selling artisanal pralines, the raw chocolate quality is probably not the thing to be tampered with, even at the price of higher costs.
Cash flow is king (or queen).
Not to be too ominous-sounding, but a 2019 study by U.S. bank and cited by SCORE shows that a staggering 82%(!) of businesses fail due to cash flow mismanagement. 2021 will probably not be more favorable to business owners in terms of cash-flow. Therefore, you should take all reasonable measures possible to make sure you maintain a healthy cash-flow. Among the principles to keep in mind, we suggest:
- Ask an accounting professional to perform cash-flow projections and cash-flow analysis to help you make more knowledgeable decisions to improve your cash-flow.
- Almost obvious, but still worth mentioning: Make sure you pay as late as you are allowed to by your payment terms, without the risk of late payment.
- Try to renegotiate payment terms with your vendors, or “shop” for vendors with better payment terms, if possible.
- Get paid as early as possible. Make it easy for your clients to pay you. Offer early payments discounts if you can afford it.
- Implement a payment scheduling system to make sure you optimize your payments and move your Accounts Payable and Accounts Receivable to an online payment platform to reduce payment lags. Opt to use ACH payments over paper checks when possible.
- Look into government/private financing options (such as the Paycheck Protection Program.
- Use credit cards when possible to pay vendors to defer payments to the next billing cycle and enjoy the extra float. Look into services that enable you to pay vendors with a credit card (such as Melio), even if the vendors don’t accept them.
Melio is a free vendor/bill payment tool that maximizes cash flow and minimizes busywork. Pay any vendor using bank transfer or debit card for free even if they only accept checks! You can also use your credit card where cards are not accepted to hold onto your cash longer and earn card rewards! Accounts Payable re-invented. Melio automatically syncs with your QuickBooks and even mails checks on your behalf to vendors so you don’t need to cut checks anymore.