Increase Net Income by Reducing Costs

January 6, 2011

With this being the first week of a new year, it is a good time for business owners to think about how to increase net income in 2011. The knee-jerk answer is to increase gross income by increasing sales. This thinking is not flawed, as more sales should lead to higher net income. However, simply increasing sales is a one dimensional approach to increasing the bottom line. On a profit and loss statement, between the gross income and net income, there are a lot of costs. Decreasing these costs allows each sale to generate more net income, making it entirely possible to increase net income even on stagnant or shrinking sales. Cutting costs while increasing sales is even better for the bottom line.

The following are some of my suggestions for increasing net income by reducing costs.

START WITH GOOD FINANCIALS

Good financials not only show how much money is coming in and out of a business, but in great detail show WHERE the money is coming from and WHERE the money is going. Without good financials, it will be impossible to know which cost cutting efforts will significantly cut into sales and which will have little or no effect on sales.

Start looking at the financials. If good financials are not available, hire a bookkeeper or accountant to set up a proper accounting system and generate them. Financials will only cost a couple hundred dollars per month for most businesses, and this investment could be worth thousands of dollars per month if the information is used properly.

If you do not currently use an accountant or bookkeeper, call me or send me an email and I will gladly suggest a few professionals I trust.

ONLY KEEP THE RIGHT EMPLOYEES

Employees are the usually the largest single business expense. While most businesses cannot survive without employees, cutting costs while increasing sales is about having the right employees in the right positions, and not necessarily just fewer employees.

Every person drawing a check from a business needs to be doing one of two things: (1) Making the business money; or (2) Saving the business money. Identify how each employee is either making the business money or saving the business money. It is not always obvious.

For example, do not fire a receptionist doing tasks for $10 per hour when other staff will have to do this work at $25 per hour. The receptionist is saving the business money.

A contrary example is that of a salesperson who does not up-sell or cross-sell. This salesperson is not making the business money because anyone can answer simply answer a phone and take orders from customers. Replacing this salesperson with another, more motivated salesperson who actively seeks out new sales and works to increase the amount of goods or services sold in each sales transaction is an example of a salesperson who makes money for a business.

ADVERTISE WITH A NARROW FOCUS

Advertising is another typically large business expense. Advertising smarter by narrowing the focus of distribution will reduce costs while giving a greater return on investment for each advertising dollars.

Figure out where customers are located and direct advertising there. Is a client going to drive from their home or office to a frozen yogurt shop miles and miles away, or will they just go to the closest place to get what they want?

Also think about the media in which advertisements are placed. Do not advertise hearing aids on the internet or snow boards in a newspaper. Understand how to best reach customers, and quit wasting money advertising in the wrong media.

If it is unclear where clients are coming from or how they learned of the business, just ask them at the first contact or point of sale.

FASTER INVENTORY TURNOVER

Streamlining procurement is another way to save big money and free up capital. Many businesses get sucked into buying too much product from distributors offering price breaks on quantity. Yes, a 10% price break might be extended for restocking in bulk, but if the inventory does not turn at least every 30 to 90 days (this is industry dependent), too much capital is tied up in inventory and increases costs in several ways.

Costs associated with slow inventory turnover include spoilage, obsolescence, cost to insure inventory, and cost to warehouse inventory. Spoilage and obsolescence will cause inventory to be discarded or sold at deep discount, while high insurance premiums and high rental rates also create unnecessary drains on gross income. If too much of a perishable or trendy item is stocked, when the perishable spoils or when yesterday’s trend is no longer selling, that inventory must be sold at a deep discount (if you are lucky) or thrown in the dumpster; a costly waste of your money.

Consider using necessities or options contracts to secure the ability to purchase at a discount and never run out of inventory while at the same time not purchasing more inventory than necessary at any given time.

PAY LESS TAXES

Every business needs a solid strategy to deal with taxes. While paying taxes is unavoidable, there are options available to businesses to reduce tax liability.

Classification of a worker as an independent contractor rather than an employee passes the duty to pay employment taxes and workers compensation insurance to the independent contractor. While this savings is significant for the business, not every worker is eligible for classification as an independent contractor and improper classification of a worker as an independent contractor can result in expensive fines and other penalties from the Internal Revenue Service, so get some professional advice before reclassifying any employees.

The type of business entity used to conduct business can also have a significant impact on tax liability. For example, sole proprietorships are typically more heavily taxed than corporations organized under Subchapter “S” of the Internal Revenue Code. These “S-Corps” allow the business owners to split income between salary subjected to employment taxes and net income not subjected to employment taxes; a difference of 15.3% in tax liability.

A business attorney can help determine which business entity will be best suited for reducing tax liabilities in a given situation.

CONCLUSION

If you have any questions about the above ideas for improving your bottom line, I welcome you to give me a call or send me an email for a clarification or more details. I wish you all the best in 2011, and hope it will be your most profitable year yet.

Warm Regards,

Michael J. Leonard, Esq.
Attorney at Law
San Diego Corporate Law

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