An Accountant’s Guide to Reviewing and Reducing Operating Expenses
June 21, 2022
By Trent McLaren
Looking through a company’s general ledger, you have a bird’s eye view of where the money is going. Whilst the figures might be minutely detailed, with every individual fuel charge and cup of coffee shown, the information needs more context and categorisation if cost-cutting measures are the aim. Here’s a quick guide for accountants and business owners looking to reduce expenses where it matters the most.
The difference between operating/non-operating expenses and COGS
First, let’s cover what operating costs are in the business world. All costs are monies that reduce your profits in the immediate term, which might mean lower salaries for owners and staff, but it can also mean less investment in research, machinery, efficiency drives, training initiatives and so on. In other words, lower expenses today can mean exponentially higher profits in the future, so cost-cutting with short-term goals can backfire when effective costs go up through managers’ actions.
Expenses are generally divided into two types: operating expenses and non-operating expenses.
Operating expenses are the payments you make to help you produce your product or service. This includes office staffing and outsourcing, marketing, office space, transportation costs, etc. Often, these expenses are incurred because “that’s the way we’ve always done it” — however some might turn out to be unnecessary luxuries, and others could be done cheaper by modernising or cutting waste.
Non-operating costs are the costs that are incidental, or perhaps avoidable. These tend to be less predictable and can often vary widely. Here, we’re referring to things like legal settlements, depreciation, interest on loans, unsold inventory and its storage. You can imagine a business running perfectly well without any of these expenses through better stock management, more fluid cash flow and overall due diligence..
Finally, there’s what’s known as cost of goods sold (COGS). This applies to manufacturers and refers to the ongoing costs of raw materials, transportation, energy - anything that is directly involved in making the product — not the office staff, premises or marketing. While it’s often possible to reduce COGS (for example negotiating bulk deals from suppliers for raw materials), this is probably where you have the least flexibility, as these costs tend to be market-set and are more likely to be fixed. Cutting the costs of the equipment use to produce your product may be possible, however, it’s likely the tools you’re using are standardised and reducing costs here would likely risk you jeopardising the quality of your product.
How to get an operating expense ratio
Your operating expense ratio (OER) is a way of measuring the efficiency (or inefficiencies) of a business. This is a great metric to use when you want to review how well the company is performing in terms of how the operating expenses are being managed. The business could be performing really well in sales and appear to be a great success, but if its operating expenses are too high it can be at risk.
It’s a simple calculation once you’ve got all the expense stats in front of you. The figure is calculated by dividing total operating expenses by gross revenue.
How to strategically reduce operating costs
If you’ve calculated your operating expense ratio and see a need to review and reduce your operating costs, you need to embark on a carefully considered approach to doing so. The ultimate goal is to reduce this number without compromising on quality and performance. Below, we’ve outlined the steps needed to get you started.
1. Setting a goal
Before you start reviewing expenses, it’s always good to have a figure in mind. A 10% reduction in operating expenses might be a good target at first.
Choosing a target that’s too small, 2% reduction for example, will limit your potential benefits. But more importantly, you will probably be within the margin of error, or the ebb and flow of your monthly business outgoings — you might be satisfied that you’ve reached your goal when in fact it was just a seasonal fluctuation.
Going too high — let’s say 40% reduction — can be damaging too. Sometimes, efficiencies need time to settle in before you can see the medium-term effect of your actions. Think about these examples:
- You might be able to stop your monthly staff night out, for example, and save a couple of thousand dollars a month, but what will be the effect on staff morale, resignations, and talent recruitment costs?
- Reducing your advertising spend is guaranteed to help your immediate costs, but how will you win new customers?
Taking things slowly and doing some basic cost/benefit analysis can help here. And of course, you can continue to make extra savings once you’ve hit your goal and measured the tangible and intangible effects.
2. Identifying inefficiencies
The crux of any measure to reduce business operating costs is looking at individual items on the general ledger and working out if there are more efficient ways of doing them. Even better, identifying items that can be eliminated altogether as long as there aren’t any unforeseen effects.
Some simple questions you can ask yourself are:
- What manual labour tasks could be automated?
- Are there any technologies that could make the business more efficient?
- Are there in-house tasks that would benefit from outsourcing? (Or vice versa)
- Are you paying the best possible price for your goods and services? Could you shop around or negotiate with your current suppliers?
- Are you paying your bills on time or are you letting interest accrue? Can you pay invoices earlier and receive a discount?
- Are you paying too much insurance for your business’s risk profile?
- With many employees working a hybrid work model, could you move to a smaller office space?
- Is your advertising being targeted at potential clients efficiently?
- Are benefits and incentive schemes actually paying off?
- Could regular machinery maintenance be cheaper than unplanned repairs?
- Are you encouraging energy-efficient power and reducing other utility costs?
- Are you on the cheapest phone and internet tariffs for your speed and bandwidth needs?
All businesses have different profiles, but these are pretty typical ways you can make small individual savings that add up to a healthier bottom line. Your business will no doubt have other specific costs, but treating each one as its own distinct cost-saving opportunity is a beneficial way to optimise spending.
3. Virtual Corporate Cards & Expense Management Software
Virtual corporate cards have created a much more controlled method of managing business expenses, allowing finance teams and business owners to define budgets and control spending before the expenses occur.
Weel's virtual corporate cards are ‘issued’ to individual employees via their digital wallet or Apple Pay, allowing them to make purchases using their phone from your central account. You can set different limits for different stakeholders, and control everything from travel expenses to office costs at the source.
Because all of this data is centralised, our software can automate manual tasks and save finance managers up to 90% of administrative time. It can improve the way businesses process expense reports, code expenses, collect receipts, process approvals and manage reimbursements.
Best of all, you get to see all your company spending as it happens, and when it’s time to sort out your expenses and start making efficient savings. Everything is categorised and quantified so you can see the areas that are the most ripe for optimisation.
Why not see how Weel can help you monitor and reduce operating expenses by booking a demo today?