By Jay Carter, Principal
Charlotte Office, Corporate Finance Associates
Growing top line revenues has been the focus of most business owners and managers over the past decade, while managing expenses has received less attention. Why is this? One explanation is the seductive feeling of satisfaction and well-being that accompanies recurring periods of revenue growth. Unfortunately, there is an unhealthy side effect associated with this euphoria — expense creep. Expense creep is the gradual increase in company expenses due primarily to inadequate attention to them. This may go unnoticed for years because intoxicating sales growth masks the symptoms. In a strong market environment, a state of equilibrium may be reached between expense creep and the healing revenue growth. This can continue indefinitely with no apparent adverse effect on the company. But once revenue growth stops — or even worse — becomes negative, a dangerous imbalance develops.
The current economic recession is the ideal environment for the effects of expense creep to be realized. The euphoria of sales growth has long worn off. Boardroom discussions about company profitability have shifted from how to sustain double-digit growth to whether the bottom line will be positive or negative. Owners and managers who are feeling the pain are now forced to devote their attention to expenses. For those who are not experiencing the pain, consider the cries of the former group a valuable reminder. Both groups will benefit from a current and thorough review of their companies’ expenses and reducing them where possible.
Giving proper attention to expenses is much more satisfying if first put into proper perspective. Cost savings should be viewed as value builders. The value of most companies is a function of the amount of cash flow it generates. In today’s market, a profitable company with $20 million in revenues might sell for 4 and 6 times annual cash flow. When helping a client prepare a company for sale, I will review all expenses carefully and identify any that should be considered non-recurring or otherwise exceptional. I know that when the company is sold, for every $1.00 of expense that can be appropriately added back to the company’s adjusted cash flow, my client will receive between $4.00 and $6.00 in additional value from the buyer. This same value-building principle occurs when a company scrutinizes expenses and effectively reduces them.
For sales-growth affected owners still in need of additional motivation to dive into expenses, consider the impact $1.00 in additional sales will have on the company’s valuation compared to $1.00 in expense reductions. As a simplified illustration, assume a company generates net cash flow equal to 15% of revenues. It would take $6.70 in additional revenues to increase cash flow by $1.00 ($6.70 x 15% = $1.00). By comparison, it only takes $1.00 in cost savings to achieve the same result. Here, the expense reduction has a 670% greater impact on the company’s value than an equivalent increase in revenues!
Getting Started: Begin With Your Employees
To kick-start an expense reduction program, start with your employees. Don’t fire them; ask your employees for their ideas for cutting costs. This is a great place to begin your expense reduction program for a lot of reasons. Your employees are fully aware that these are difficult economic times. By asking for their ideas, you’re not merely recognizing the reality of your company’s situation; you are honoring them with an invitation to become part of the solution. You are communicating to them, “we’re all in this together.” You are building loyalty at a time that it really matters. In addition, because your employees are much more familiar with the wasteful spending that occurs in their particular areas of the company than you are, they will undoubtedly come up with cost-cutting opportunities that you may have never considered. Finally, this is a quick, inexpensive and lasting way to build value in your company at a time when other ways (like increasing sales) are not an option.
To demonstrate the effectiveness of enlisting the help of employees to come up with cost-saving ideas, I recently sponsored a contest at a local professional services firm. The firm asked each of its employees to contribute their ideas for cutting expenses, either for their own firm or for other companies. To encourage participation, I offered three gift certificates (valued at $10 each) to three randomly selected contributors. The results were incredible! Here is sample of what this $30 investment for a 75-person firm produced:
10 Employee-Generated Cost-Saving Ideas
- Organize expenses from largest to smallest and work your way down the list; review each expense and get competitive bids or request price reductions where possible.
- Encourage employees to work from home; reduce occupancy/parking expense.
- Minimize travel expense by substituting conference calls for travel when possible, and utilizing local or web-based training resources.
- Scale back or eliminate non-essential expenses, like Christmas parties and birthday lunches.
- Save/don’t print. Print only when necessary.
- Examine each invoice that is presented for payment over the next 60 days and determine if the value received is worth the cost.
- Print on both sides of a sheet of paper.
- Eliminate duplicate copies of all periodical subscriptions.
- Consolidate purchases to reduce shipping charges.
- Turn off lights and equipment when not in use.
These employee suggestions are just the tip of the iceberg. The estimated total of these potential expense savings is $150,000 per year. For the company used in the example above, this is enough savings to offset $1,000,000 in lost revenues, and equates to an increase in the company’s value of up to $800,000. Perhaps managing expenses will become the new “growing the top line.” Just don’t forget about sales.
NOT ON OUR DISTRIBUTION LIST?
If someone forwarded this newsletter to you and you would like to
continue to receive future issues, please
sign up now.