Robert H. Gray, CPA

Too often businesses emphasize increasing sales as the only way to boost profits. Cost-cutting, when done selectively and intelligently, can be a faster way to higher profits. “Trimming the fat” should continually be on every business owner’s or manager’s mind, and a serious cost-cutting review should be conducted every year or two.

Here are nine ways you may be able to cut costs in your business.

1. Look at gross profit margins. If the margin has been deteriorating, find out why. Determine if increases in direct costs can be passed along to the customer. Analyze the product to see if it can be reformulated or redesigned for cost savings.

If you sell a number of different products, determine their individual gross profit margins and their mix. Give particular attention to low-margin products to see if it’s still worthwhile to carry them.

2. Payroll costs are a major item in most businesses. Perhaps a more efficient plant layout or automation would result in reduced labor needs. The initial investment may be costly, but more than offset by future payroll savings. Consider the use of temporary employees and subcontractors if your business is subject to seasonal variations.

Payroll-related costs are fertile areas for cost reduction. Fringe benefits can easily amount to 25-50% of direct payroll. Review employee classifications for workers’ compensation insurance. Improperly classified workers can be costing you significant premiums. Review group insurance programs. Solicit bids for the programs every three years. Consider higher deductibles as a means to lower premiums.

3. Review telephone and postage costs. Are all telephone calls necessary? Is the telephone being used effectively? Can money be saved by alternate shipping and receiving carriers?

4. Review credit policies. The longer it takes to get paid, the greater the risk of loss. The 80/20 rule states that 80% of your revenues are generated by 20% of your customers. If this is the case, it may be wise to review the other 80% of your customers to see if you can continue to serve them cost-effectively. Otherwise, your time will be better spent soliciting new customers.

5. Analyze inventory levels. Determine if any obsolete inventory can be reworked or sold for salvage.

6. Review fixed assets. Consider disposing of excess machinery and equipment. Determine whether it would be better to buy or lease major assets, especially those subject to rapid technological change and those assets used infrequently.

7. Review purchasing policies and costs of supplies, products, or raw materials. Compare prices of other suppliers. Switch suppliers where appropriate, or renegotiate for better prices with your current suppliers.

8. Enlist the aid of employees by soliciting suggestions on cost reduction. Many companies have generated significant savings using this approach. To encourage participation, consider implementing a bonus program based on a percentage of costs saved. Be wary of “quick fixes” that will have no impact, or worse, prove costly in the long run.

9. Review your expenses on a regular basis; don’t wait until a financial crisis develops. Avoid the temptation to make across-the-board cuts, because rarely do all areas of the company contribute equally to its success.

Tax and business planning is important for the success of any organization, but especially for the family-owned enterprise. Here are some important questions that owners of family businesses need to address.

1. Do you have a plan?

Without a plan, your business has no direction and possibly no future. You can be sure your strong competitors have written plans. Write a business plan that includes both short and long-range goals. Include specific goals such as profit, growth, and market-share targets. Plans for conflict resolution and transition should also be included.

2. Who’s running the store – family, outsiders, or employees?

When several family members participate in the company, an organization chart should be drawn to clearly show lines of authority. Promotions should be based on a clear, fully understood set of guidelines.

3. Should the legal form of the organization be changed?

Whether your business is a sole proprietorship, a partnership, a regular corporation, an S corporation, or a limited liability company, you should review your business form periodically to see if it’s still the best choice for your business. The legal form under which you operate can make a difference in the taxes you pay, the costs of doing business, and the amount of paperwork and red tape you’ll have.

4. Have you reviewed your retirement and fringe benefit plans?

The types of plans available depend on your business form. Besides being an excellent tax planning tool, such plans can be effective in motivating and retaining employees.

5. Are formalities observed?

Family members occasionally overlook the fact that business assets are not personal assets. Company loans to family members need to be documented. Shareholder or employee use of corporate assets, such as automobiles, may have income tax consequences. Get advice so you structure transactions properly.

6. Who’s next in line?

Many family businesses are lucky enough to have a very strong member at the helm. But that person won’t live forever.

The survival of any family business depends on how wisely one generation passes ownership to the next. The more family members, the more complex the situation is likely to become.

Facts show that only 30% of family-owned businesses survive to the second generation, and only 13% survive to a third generation. Careful planning while you’re still at the helm may prevent the demise of your business.

When you start a business, you have many decisions to make. One of those is the method of accounting your business will use for reporting income and expenses on your tax return. It is an extremely important decision. With few exceptions, the method you choose can only be changed in the future with the IRS’s permission.

The two methods generally used are the cash method and the accrual method. The cash method is probably the easiest for most people to understand and the easiest for small business owners to use. This method recognizes income when you receive a payment from a customer, and a deduction is taken when you pay cash or write out a check for a bill you have to pay.

The accrual method recognizes income when the services are rendered or the product is sold, despite the fact that you may not get paid for several months. You have “accounts receivable” in the form of money customers owe you. Expenses are handled the same way. If you buy something today, but don’t pay for it until later, maybe even next year, you would deduct the cost now. What you owe for purchases you’ve made constitutes your “accounts payable.”

The cash method is easier to understand and more closely reflects how money is coming in and out of the business. However, it doesn’t tell you how much people owe you or how much debt the business owes. The accrual method better reflects how the business is actually doing, but it is more complex and, for most business owners, more difficult to understand.

All new business owners should sit down with their accountants to discuss the pros and cons of each method and to decide what works best for their business. Many businesses are required by tax law to use the accrual method for tax reporting.

For any assistance you need in making this and other decisions for your new business, give us a call.