Saving money in operations

Small tweaks that can significantly boost the bottom line

ASIDE FROM improving top line sales, profits increase only by cutting costs. The opportunities for savings are vast, especially if controls are not fully in place. Personnel costs may reflect excess headcount and overtime pay. Operations may be inefficient, with selling, general, and administrative ("SG&A") overhead out of line. Certain equipment may be underutilized or altogether idle. State-of-theart technology might save money.

There are several ways to approach cost savings, depending on how much time and effort you want to put into it. One way would involve implementing controls, including cost accounting. Managing expenses starts with a budget, as a basis for expectations. Comparing budget to actual results highlights problems. Ideally, spending outside of preestablished parameters should require approval ahead of time. Taking budgets a step further, a cost accounting system can help pinpoint loss operations. Costly services, such as delivery, customization, or expediting, lose money unless recovered through higher prices.

Fine-tuning resource consumption takes additional effort, even involving outside experts, such as the Chicagobased profit improvement consulting firm of Stratego Partners, Inc. As Steve Brown, president and CEO, puts it, "Cost reduction consultants generate savings for clients across the entire cost spectrum of the business-core operations, headcount and process improvement, and SG&A. The good ones have intellectual capital and market intel and are able to create business leverage that the client company simply cannot on its own. For the SG&A cost categories, each and every significant spend supplier, vendor, and service provider should be evaluated for potential cost reduction including, but not limited to, banking fees and credit facilities, property and casualty insurance, health insurance and employee benefits, rentand real estate-related costs, energy, technology, telephony, travel, professional services, freight and delivery costs, office equipment, and supplies."

Personnel

Personnel is the single largest cost in most operations. Labor effectiveness impacts cash flow directly. Too many companies suffer from lags in billing due to problems with ordering, scheduling, and coordination of effort. Backlogs grow from work ordered but not done, and hence unbilled. Inefficient operations call for a rethinking.

Moreover, hiring must be controlled. Hiring should be only in response to the company's needs, with open positions advertised and competitively marketed. Pay offered should be in line with market and the company's historical practices. As to overtime, each hour increases labor costs by 50%. Proper scheduling can minimize it. When quoted lead-times are reasonable, staffing can be set appropriately to the level of work that needs to be completed. If resource needs fluctuate, on the other hand, outside temporaries offer supplemental resources that can be adjusted easily as conditions change.

Increasing productivity starts with data. In itself, time reporting can provide an immediate gain in productivity, as employees become accountable. The right automation also helps. For example, computers can make paperless the sorting, filing, matching, and paperwork done by clerical employees. Data should be entered only once, and from there used for whatever purpose necessary within the computer system. Overall, automation can result in better quality in less time. Generally, a twoor three-year payback expectation can screen proposals.

Tracking productivity against benchmarks brings to light the causes of inefficiency. For example, machinery usually has rated speeds, which benchmark capabilities. Errors and quality problems cause rework, which slows operations down. Reporting can track causes of inefficiency, including downtime, set-up, rework, and customer special services. Uncovering causes allows problems to be addressed.

Productivity can be rewarded. As an alternative to pay raises, incentives allow compensation to adjust based on performance of the company and of individual employees, relative to expectation. If operating profit is used as a basis for a management team incentive, 20% of the total improvement might be distributed through a bonus.

The personnel cost per unit of work done can also be reduced. Delegation assigns tasks only up to the level of resources actually required to carry them out. A business owner's time spent doing sales supervision, accounting, human resources, compliance reports, customer education, or similar tasks is better delegated.

As to benefits, companies with fifty or more full-time equivalent employees must offer compliant medical insurance under the Affordable Care Act starting in 2015, or face penalties for noncompliance. Companies can use various strategies to control cost, including self-insurance up to a stop loss, claims audits, wellness programs, or high-deductible plans supplemented by health savings account arrangements. Although the initial penalties to employers that fail to provide compliant coverage appear relatively low, they are likely to increase. Moreover, removing benefits may make an employer uncompetitive in employee retention. Under the Act, employees will have to pay for medical insurance themselves or face penalties of their own.

Buying

A purchasing function, independent of requisitioning, receiving, authorization, and payment, should select the vendors and place numerically controlled purchase orders. Electronic data interchange (EDI) with vendors can be used to cut down on paperwork. Periodically, costs of purchased items should be subject to competitive bidding, or at least compared to prices in published catalogues. As Steve Brown puts it, "The more an item is commoditized, the more cost will drive the evaluation. For less commoditized cost areas, remember to keep in mind all of the important attributes of the supplier and service provider relationship."

Vendor selection must consider more than price alone, as other characteristics and limitations can add substantial costs. Price needs to be weighed against order lead time, minimum order, delivery, quality, service, customization, and payment terms. Consolidating purchases gives leverage for negotiating with vendors, as does centralizing buying for multiple locations. The least costly arrangements are consignment and drop ship. There is a choice of making or buying. The decision depends on the effect on costs. Outsourcing saves only insofar as internal costs are reduced. Insourcing, on the other hand, becomes feasible as volume grows.

Prior to payment, vendor invoices must be matched with purchase orders and receiving reports. Executives having check-signing authority should not requisition, purchase, maintain accounts payable, prepare checks, mail checks, reconcile bank accounts, or be able to adjust the general ledger accounting records. They also should have access to supporting documentation while signing. Other controls to be considered include: Dual-signature requirement for larger checks; wire transfer procedures that separate initiation from approval; ACH and check filters set to limit payees and amounts; and positive pay, under which the bank matches account number, check number, and dollar amount of checks presented against a previously authorized list. Credit cards generally should not be given to employees, as doing so provides unusually great opportunities for fraud. If issued to employees, cards rather should be special-purpose, restricted to certain vendors, and used only by a responsible purchasing manager. Obtaining prompt payment discounts may be worthwhile, even if the company has to borrow to do so. Traditional 2/10 net 30 terms equate to an annual interest rate that exceeds 36%.

Buying right saves money. For example, facility costs are significant. Decisions as to locating must consider resource availability and costs; service needs and market proximity; logistics; business climate and incentives; and funding sources. There may be no need to locate in a high-rent district, particularly if tax savings are obtainable by moving. Energy costs can be controlled. An energy audit may disclose savings from automated adjustments to heat, lighting, and hot water. Alternative energy brokers and suppliers also offer opportunities for cost reduction. Converting from electric to natural gas may save as well.

Spending on selling activities must pull its weight in terms of profit contributed by the sales generated. At a 40% profit contribution per sales dollar, for example, an expenditure of $100,000 to increase sales must produce at least $250,000 in sales revenue just to pay for itself. By the same token, sales commissions should be paid only upon collection from the customer.

Unless collections are timely, accounts receivable may incur substantial hidden costs in terms of financing, handling, and even bad debts. Where possible, as with new customers or special orders, deposits should be obtained in advance. As orders are completed, they should be billed immediately. Staying in front of customers can start with confirming the receipt of invoice within days of it being sent. Weekly contact is required as accounts become delinquent. Some collection people favor phone calls over e-mails or written correspondence because calls are harder to ignore. Whichever approach is chosen should be implemented systematically, and followed up with credit holds and placement with collections.

Hiring should be only in response to the company's needs, with open positions advertised and competitively marketed

A cost-saving checklist

Personnel

* Rethink operations

? Control hiring

? Minimize overtime

? Consider temporaries

? Improve productivity

? Automate

? Reduce rework

? Provide incentives

? Delegate appropriately

? Control medical insurance costs

Buying

? Establish independent purchasing

? Weigh total cost

? Centralize buying

? Arrange vendor consignment or dropship

? Choose to make or buy

? Control payment

? Take prompt payment discounts

? Manage space and rent

? Control energy costs

? Justify selling expenses

? Collect invoices timely

By William H. Wiersema, CPA, EA Contributing Editor