How to Balance Revenue Growth and Cost Reduction: A Q&A with Ben Cook
In this Q&A session, we delve into the critical balance between revenue growth and cost reduction in the business world. Ben Cook, President of Acumen Learning, provides insights into these strategies and their significance. Let's explore the impact and how business acumen informs these decisions.
QUESTION: Ben, can you shed some light on the two common scenarios—reduce costs and increase sales— that executives often grapple with when it comes to business growth?
Absolutely! Well, in the world of business, you're going to frequently find yourself dealing with two common scenarios. First, you'll often hear the rallying cry from executives "cut costs, cut costs, cut costs!" as if it were a mantra. On the flip side, they likely are also pounding the table, urging everyone to "step up our game and start selling more to drive the top-line!" So, it's really a tale of two strategies – selling more and growing top-line revenues (or ‘sales’), or cutting costs. It all depends on the company's strategy and what the executives believe will be most effective. But this isn’t really an either-or scenario, it truly needs to be a gentle balance of both.
You often emphasize cost reduction. Could you tell us more about the significance of this strategy?
Certainly. Cost reduction is a common focus for many organizations. The reason is that by reducing costs, a company can directly improve its profitability. This is especially evident during certain periods, such as the end of a quarter or fiscal year when organizations strive to maximize their profits. Effective cost reduction strategies can directly impact the bottom line.
However, it's important to note that cost reduction goes beyond mere cutbacks or layoffs. While these can be important strategies, it's equally crucial to identify inefficiencies and enhance productivity. Often, employees associate cost-cutting with minor changes, like using black ink instead of color. While even small measures are important, I'm always challenging our team to think more creatively. Cost reduction should encompass process optimization, waste reduction, and working smarter. When your CEO emphasizes cost-cutting, it involves more than just budget slashing; it's about becoming more efficient and finding innovative ways to enhance productivity. These combined efforts, along with direct cost reduction, can significantly impact a company's profitability, especially during critical periods like when you're trying to hit year-end financial goals.
Ben, the P&L is frequently discussed with employees and shareholders more than other financial statements, why does it get all the love?
Ah, the financial statement of choice in many conversations is the Profit and Loss (P&L) statement, or as some people like to call it, the income statement. It tends to be the go-to statement for discussing how a company is performing financially. And in it, you’ve got three main players.
First, there's top-line"sales," which is all about the revenue a company brings in.
Then second, we have the costs to operate the company:
Cost of Goods Sold or ‘COGS’ which are the direct costs it takes to manufacture the products or the costs to buy the products to then sell.
Operating Expenses, which is often referred to as SG&A which stands for ‘selling, general, and administrative expenses.' These costs cover the costs related to selling and distributing the products as well as the running of the business day-in and day-out, items such as marketing, sales commissions, distribution costs of the products to the customer, HR, IT, finance, legal, etc.
The third major cost is Product Development/R&D which is the costs to develop a product you will be able to get to the market at a later date.
After all those costs, which also include taxes, etc. you get the last part of the P&L which is the bottom-line profit or also known as ‘net income’ or ‘net earnings.’
But here's the real beauty of the P&L statement: every employee, regardless of their role, is represented on the P&L and has an impact on it. Every person in the organization can either contribute to increasing sales or decreasing costs, influencing the company's profitability. Employees need to understand that they have a direct hand in pulling these levers to make the company more profitable. Moreover, shareholders closely scrutinize the P&L to gauge whether the company is headed in the right direction. They want to see trends that suggest the company's employees are making the right moves to enhance profitability. In essence, the P&L statement highlights the actionable areas where employees can make a difference in the company's financial health. It's a valuable tool for aligning employee efforts with business objectives and demonstrating the company's commitment to profitability.
Ben, often times in your courses you'll reference the average gross profit margin for companies in the S&P 500, what insights can you provide?
When we're talking about those big players in the S&P 500, the average gross profit margin tends to hang around 45%. It gives you a good sense of how profitable their products or services are. It basically means that for every dollar the company is able to generate in sales, they have 55 cents in direct costs (or COGS). And they have 45 cents left over. It makes for a good benchmark to measure the impact of different strategies.
Speaking of strategies, can you walk us through the impact of increasing sales by $100k on a company's profitability?
Certainly, let's look at it. Picture a company that manages to drum up an additional $100k in selling more products/services. Now, that might sound like a victory parade, but here's the deal: with greater sales comes greater responsibility. They've got to shoulder various costs like the cost of goods sold (COGS) and the overhead costs that are captured in SG&A (Selling, General, and Administrative) expenses.
So let's break that down. First, they tackle the cost of goods sold, covering expenses like labor, raw materials, shipping, and quality testing – the essentials for preparing products for sale. Using our S&P average, about 55% of every $100k in sales goes into these costs, leaving around 45% or $45k as gross profit.
But there's more to the picture! They also have expenses like commissions for salespeople, distribution costs, customer service expenses, and possibly increased marketing – these are the SG&A expenses, eating up about 25% or $25k of every $100k in sales. When you crunch the numbers, subtracting COGS and SG&A from the extra $100k in sales results in the operating profit, approximately $20k. However, before you start tallying profits, there's one more step – taxes. Companies pay taxes based on profits, not just sales, with an average tax rate of around 20%. This means about $4k goes to taxes from that $20k operating profit.
So now, to answer your question, after all these calculations, when the average company boosts its sales by $100k, what's left in the profit pot is roughly $16k more. It's like a slice of the pie – substantial, but not the whole pie. And that is how the profitability equation unfolds with a $100k boost in sales.
Now ask me what happens when a company reduces costs by $100k.
Ok, what happens to profitability if we reduce costs by $100k?
I'm glad you asked. When a company manages to slice off $100k from its expenses, it's like discovering hidden treasure. You see, this $100k reduction in costs is like putting money directly into the company's pocket. Because I didn’t spend it, I get to keep it… it’s not in someone else’s pocket, it's still in your pocket.
Now, let's consider the impact. After all the hard work and smart decisions to cut costs, the company gets to keep all of that $100k, except for one little thing: taxes. We pay taxes based on operating profits, not sales. The average company's tax rate hovers around 20%. So, when we take out 20% in taxes from that $100k cost reduction, we're left with $80k in additional profit. So, reducing costs by $100k is a significant win for profitability. It's akin to having extra money in your pocket. In a nutshell, it's a direct and substantial contribution to the company's overall profitability.
To put it in perspective, if you add $100k in sales volume, that translates to only about $16k more in profit, but if you manage to cut costs by $100k, you're looking at an extra $80k in profit. However, I want to mention again and again that neither is better than the other. Depending on your industry, the products you’re selling, the market, and many other factors, determines why a company would choose one method over the other. And also, I want to add that if you can increase the price of your products/services, you also get that $80K to the bottom line. So reducing of costs or raising price have great benefits to the bottom-line. But also, because you can’t your way to prosperity, you need to also grow sales, customers, market share, etc. to remain vibrant in the marketplace!
So there's a balance?
For sure! Striking the right balance between increasing sales and cutting costs is crucial. And executives wrestle day-in and day-out finding that sweet spot between the two strategies. While cost reduction can quickly boost profitability, it's essential not to go overboard. A balanced approach that considers both sales growth and cost reduction is the key to achieving long-term success.
How can employees contribute to both sales growth and cost reduction based on your advice?
Employees can make a substantial impact on both fronts by connecting their roles to sales growth and cost reduction. Developing business acumen helps employees understand how their actions can influence profitability. This dual focus empowers the company to invest in research, talent, and marketing efforts while maintaining a competitive edge. It's a win-win situation where employees play a pivotal role in driving the company's financial success.
Ben, last question. How does having strong business acumen help individuals and companies determine the best growth method—increasing sales or reducing costs—for their unique circumstances, and why is business acumen so important?
Business acumen acts as a compass for navigating the business world. It empowers individuals and companies to see the bigger picture and make informed decisions regarding the most suitable growth strategy. With a deep understanding of their industry, competition, and market dynamics, they can assess whether pushing for increased sales aligns with product demand and market trends.
Alternatively, when struggling with profitability, business acumen enables them to identify inefficiencies and areas for cost reduction through financial and process analysis.
Now that you've explored the impact of increasing sales and reducing costs, let's engage in two learning activities you can easily do during your next team meeting:
Exercise 1: 100 Up 100 Down
Split your team into groups.
Present them with a scenario: Imagine your company had an additional $100,000 in its budget. You have two options: Invest the entire amount in efforts to increase sales or cut costs.
Give your teams 5-10 minutes to discuss which option they think would have a bigger impact on the company's profitability.
Each group should then present their choice and their reasoning to the rest of the team.
Answer: While your team discusses this scenario, keep in mind the insights from our Q&A session. When you add $100,000 in sales volume, it typically translates to about $16,000 more in profit. In contrast, when you cut costs by $100,000, it usually results in an extra $80,000 in profit. These numbers are based on averages from the S&P 500, representing some of the largest and most established companies. However, it's essential to remember that the choice between these strategies depends on various factors. Neither is inherently better, and it's crucial to find the right balance between sales growth and cost reduction.
Exercise 2: Cost Cutting Idea Challenge
Challenge your team to come up with as many cost-cutting ideas as they can in 5 minutes.
Encourage them to think creatively about ways to improve efficiency, reduce waste, or optimize processes.
After 5 minutes, each team member can share their top ideas with the group.
These exercises are designed to help your team think critically about the balance between increasing sales and reducing costs, as well as encouraging a culture of continuous improvement. It's a great way to apply the principles discussed in our Q&A session to your own business context. Have fun with these exercises and discover new ways to enhance your company's profitability!
Continue your learning…
Breaking down the P&L
Why Business Acumen Should Matter to Everyone
The Impact of Business Acumen on the Sales Process
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