admin posted on February 08, 2010 14:30
There are two basic elements to running a profitable business: income and expense. You have much less control over the income; however, there is usually more emphasis towards increasing the income. You’ll find that controlling expenses is just as important as increasing income when trying to improve profitability. You could be making large amounts of sales, but if you aren’t controlling your costs, it will kill your profitability.
Controlling Operating and Fixed Expenses
There are two categories of expenses associated with a business, fixed expenses and operating expenses. Fixed expenses remain constant for the most part. Since they don’t fluctuate, the focus should be on controlling operating expenses (variable expenses). For example, in a sales environment, they increase as sales activities increase. In a production environment they change along with an increase or decrease in production.
Examples of Operating Expense:
- Sales commission
- Hourly wages
- Advertising
- Promotions
- Consulting fees
- Training
- Freight
- Equipment maintenance
- Vehicle maintenance
Operating Expense as a Percent of Gross Profit
Since operating costs are directly related to operating activities, they should be analyzed as a percentage of gross income.At the end of each month, calculate the percentage of operating expense to gross profit from the income statement. Once the percentage is calculated, they can be compared to past data and budget numbers.
Expense Control Budget and Forecast
The budget is a tool that helps you track operating expense, so you can control them.The forecast is basically a prediction of future income and expenses. Once the forecast is created, the percentage of operating expense to gross profit is used to create the budget.The calculation for each individual expense account should be used for creation of the budget.
Once the budget is created, expenses should be monitored so that expenditures are kept within the budget limits. If any specific areas of expenditures are exceeded, take a closer look to see why. From there you can determine if the percentage needs to change due to unforeseen circumstances, or if there were unnecessary purchases made.
In summary, it’s best to concentrate on controlling operating expense. A budget should be created and expenses should be contained within the limits of the budget. If expenditures exceed the budget limits, further research should be conducted to determine the root cause. Following these simple guidelines should help to increase the profitability of the company. If you need help figuring the numbers or creating the budget, your accountant can be a great resource.