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Overhead Expense Reduction

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Predetermined Overhead Rate

Overhead Expense Reduction

As a general precursor to Overhead expense reduction, Group Purchasing Organizations, Co-ops and Consortiums always lead to lower prices because they aggregate spends and create buying power. This may be true for smaller spends but as spends get larger ($100,000+ annually), you will often do better on your own when a supplier can customize a program to your specific purchasing patterns and needs.


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Category Specific Expertise

In reducing overhead expenses, expertise in purchasing for one cost category or in the request for proposal process will produce similar results in another cost category. What expertise in purchasing really means is an understanding of the unique data requirements and what drives supplier pricing to achieve the best results. You may use the same process in different categories. But without the category specific information, the results may not be the same at all.

Category specific information includes changes in the industry, contract nuances, and benchmark data.

Stay Loyal to The Supplier

Loyalty to a supplier always translates into the best value for your company (value = price + service) as well as the best opportunity to reduce overhead expenses. Quite often, long time loyalty leads to complacency from both the supplier and the purchaser. Industries and companies change over time and vendors providing operating supplies and services are no exception. Modest price increases year after year may seem acceptable when in reality the market may have changed, and the cost should actually be going down year after year. Compounding increases add up over the years.

How To Reduce Overhead Expenses

There are three things that you can do to reduce overhead expenses:

  1. Lower Costs with Incumbent Suppliers
  2. Ask Vendors to Help Manage Spend
  3. Create a Competitive Environment for Each Category

Lower Costs With Incumbent Suppliers

Ask your incumbent suppliers what you can do that will result in lower costs from them. Lower Cost can lead to a smaller Overhead-Rate which ultimately can lead to a reduction in overhead expenses. Work with your vendor as a team member – not as an adversary. If you can change a process or an ordering habit in your organization that reduces your vendor’s expense, then your vendor should reward you with lower prices which can lead to reduced overhead expenses.

Ask Vendor to Help Manage Spend

Ask your vendor to help you manage the spend. A proactive approach must be taken to reduce overhead expense. Are you leveraging the vendor’s platforms for ordering and managing information? Or can they track purchases by department and provide invoices already allocated to departments to ease the work of your Accounting Department? Can they inform you if employees do not follow established business rules (e.g., buy-off contract)? Do they have the technology to prevent your employees from buying off contract without proper approval?

Create Competitive Environment for Each Category

Create a competitive environment for each category. Let your team and vendors know that there are no “sacred cows“. Have someone other than the supplier’s daily contact manage the expense review process. This enables greater objectivity and keeps personal relationships out of the process. Then give suppliers all of the information they need to sharpen their pencils and minimize their risk. The more they know about your usage and requirements, the better. Customers who inspire confidence and minimize the suppliers’ risk are rewarded with the most aggressive pricing. Reducing overhead expense requires an understanding of both your personnel, as well as the vendor’s.

When you know your overhead and how much you need to reduce it by, you can add real value to your organization.

The CEO's Guide to Improving Cash Flow


Overhead Expense Reduction

Originally posted by Jim Wilkinson on July 24, 2013. 

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Maximizing Your Bottom Line In 3 Simple Steps

Sales are great, but wouldn’t they be better if you were actually able to reap the rewards? Many CEOs that were not trained with an accounting/finance background struggle to understand profitability. They think that if sales are great, then the business is great. But when sales increase, inventory and overhead increases. Productivity also decreases – due to exhaustion or overwork. Collections lapse because there isn’t a “pressure” to collect. And unfortunately, that is when companies suffer the most. Sales start to decline, but they don’t change their habits. In this Wiki, you will learn how everything below sales on your income statement is critical to your company’s success and how you should be maximizing your bottom line – net income – at any stage of your company’s life cycle. Let’s look at how maximizing your bottom line in 3 simple steps can happen.

What is the Bottom Line?

First, what is the bottom line we are referring to? It is the net income on your income statement or P&L statement. This is what you have left after all the costs of goods sold, administrative expenses, and overhead have been subtracted from revenue. We look at this number carefully because that is how much you are able to put into retained earnings or reinvest back into your company. In addition, the amount can be used to issue dividends to their shareholders. Maximizing your bottom line should be an integral part of your company’s processes.

Profitability starts at the top of the income statement. If your prices are not set to create profitable environment, then you will be not able to maximize the bottom line. Learn how to price for profit using our Pricing for Profit Inspection Guide.

Maximizing Your Bottom Line In 4 Simple Steps

There a are several ways to maximize your bottom line – some more extensive and time consuming than other. But there are 3 areas to focus on to maximize your bottom line – including productivity, overhead, and collections.

1. Productivity is Key

It’s been a common theme among business blogs and news sources (Entrepreneur, Forbes, WSJ, etc.) to improve productivity. Why? Because productivity is key in maximizing your bottom line. But what really happens when you improve productivity? You have more supply, decrease the cost to produce 1 unit, and increase sales. It speeds up your operations so that you can fulfill more orders for quickly.

2. Manage Overhead

Great revenues have very little meaning if your overhead costs are not properly managed. Look deeper into your overhead expenses and find out if there are any costs you can reduce or completely remove. The problem is often more complex than large expense accounts on the P&L. You must interact with various departments to think critically and solve problems. Ensure that every single overhead cost is necessary to provide the desired service levels. Maximum controllability over costs leads to higher profits for the company to reap.

3. Collect Quicker

Collections are an important part of business. If a company sells $10,000 worth of product but only collects $3,000, then their cash is tied up in inventory, etc. As a result, they experience a cash crunch. We have worked with clients who were in the same situation and they neglected to ever collect the outstanding balance. Their bottom line suffered, but they didn’t think to look at their collections process. There are two metrics that you can look at to monitor collections and use to collect quicker.

The first metric is DSO. Do you know your Days Sales Outstanding (DSO)? This is a great measurement to know where you are currently and how by making slight adjustments, you can increase profitability. Use the following formula to calculate DSO.

 DSO = (Accounts Receivable / Total Credit Sales) * 365

The second metric to look at is Collections Effectiveness Index (CEI). This is a slightly more accurate representation of the time it takes to collect receivables than DSO. Because CEI can be calculated more frequently than DSO, it can be a key performance indicator (KPI) that you track in your company. If the CEI percentage decreases one month, then leadership are alerted that something is going on. The goal here is to be at 100%.

CEI = [(Beginning Receivables + Monthly Credit Sales – Ending Total Receivables) ÷ (Beginning Receivables + Monthly Credit Sales – Ending Current Receivables)] * 100

Another method to collect quicker is to tie receivables to the sales person’s commission. This will not only encourage your sales team to be part of the collections process, but it will help keep your company cash positive.

Effective Strategies for Improving Profitability

While we’ve been focused on maximizing your bottom line as your current financials stand, we also wanted to share some effective strategies for improving profitability.

Price for Profit

Are your prices leading to a satisfying net income?  If not, then these are some questions you can inquire:

  • Are additional costs being reflected on the price?
  • Are you using Margin vs Markup interchangeably?
  • Is your overhead being covered?

The solution might be simple: Adjust your price!

Learn how to price for profit using our Pricing for Profit Inspection Guide. This whitepaper will help you identify if you have a pricing problems and how to fix it.

Create Standard Operating Procedures (SOP)

Also, create Standard Operating Procedures (SOP). SOPs are step by step instructions written by a company to assist employees in completing routine procedures. They are necessary in a company to ensure operations run smoothly. The better your company’s SOPs are, the more efficient it will run. Create operating procedures that are simple, easy to read, and most importantly make them lead to a purpose.

Focus on Profitable Customers

Identifying profitable customers is instrumental to a company’s success. Once you completely identify your most profitable group of customers, focus your attention on them. Use your marketing funds primarily on you most profitable customers. A customer outside of that target market is still a viable customer, but they just shouldn’t receive as much marketing attention since they are not their primary and most profitable customer segment.

When maximizing your bottom line, start with your prices and pricing process. Access the free Pricing for Profit Inspection Guide to learn how to price profitably.

maximizing your bottom line

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CFO: Income Producer vs. Overhead

It’s often said, “you don’t need a title to be a leader.” But regardless of titles, it’s important to take note of the difference in roles.

income producerOne of the many negative effects of the recent economic downturn is that we’ve seen many companies fire their CFOs because they view them as overhead. These companies often assign their Controller to the CFO position believing that there is little difference between the roles. Not good for the CFO who has to find a job in a tough economy, but what about the Controller who is about to face a baptism by fire?

Recently, I talked to someone who was promoted to CFO without the experience, tools, and knowledge to succeed in that role. He was frustrated, overwhelmed, and felt like he was failing in the position.

Making the jump from Controller to CFO isn’t and shouldn’t be an overnight process.  Given the predisposition by business owners to view the financial function as a money drain, the CFO’s toughest job is finding ways to add value.  Coming from a compliance-oriented role, the Controller needs time and experience to master this skill.

Income Producer vs. Overhead

What is overhead?

Overhead expenses are general business expenses that facilitate operations of the company, but cannot be directly allocated to the production of the company’s products or the delivery of the company’s services. These overhead expenses do not directly produce net income or improve cash flow.  Your challenge as a financial leader is to find a way to produce profits and improve cash flow so you won’t get lumped into this category.

What is an income producer?

An income producer is an individual who has the ability to drive net income and increase cash flow for a company. Sales revenue and net income are related, but do not mean the same thing.  An income producer can generate net income by producing high sales revenue, lowering overhead expenses, or gaining operational efficiency.  A high net income is achieved not only through sales but also by controlling costs, increasing cash flow and improving the efficiency of assets.

The way a CFO adds value to a company is by being an income producer.

So how do you become an income producer?

As the person in charge of overhead costs, it’s tempting to think that the only impact you can have on profitability is to cut overhead.  Unfortunately, a business requires a certain amount of overhead to maintain profitable growth so you’re limited in how much you can cut.  Once costs are in line, shift your focus to helping the folks in operations and sales get the information they need to make informed decisions in their areas.  You may not be able to do their jobs, but you can give them the tools they need to do their jobs better.

The New Financial Leader

Throughout my early career, I saw myself as someone who helped develop CFOs.  With the technological advances of the past few years, particularly in the financial realm, I’ve come to the realization that there are more and more financial leaders within entrepreneurial companies that don’t have the title “CFO“.  Ernest & Young conducted a survey and found that two-thirds of respondents believed that the title “CFO” was a misrepresentation of that role.  Today’s financial leader might be someone from accounting, operations, or even company management.

The Role of the Financial Leader

The role of the financial leader today is comprised of 4 functions: strategist, general, coach, and diplomat. These functions are characteristics of financial leaders who are income producers.

income producerStrategist

Just like a CEO leads the company, the CFO must act as a wingman and influence the direction the company is heading. It’s not only important, but vital to align the business and the financial strategy to result in profitable growth.

The strategist is the thinker. They define success as improving cash flow and profitability. They measure their success by tracking improvements to EBITDA.

We’ve compiled a free list of 25 Ways to Improve Cash Flow that you can download here. Take these improvement strategies into account and choose those that align with your CEO’s goals.

A critical step to improve profitability is to analyze the “3Ps of profitability”:

  1. Procurement – are your costs in line with revenues
  2. Pricing – are you pricing for profit
  3. Productivity – are you getting the most out of your resources

When analyzing your EBITDA, ask the following questions.

  • What does it really represent?
  • Why is it important?
  • Who uses it?

General

When the CFO is wearing the hat of the General, they are likely to have to make some tough calls. The company relies on the General to provide leadership and direction. In particular, the CEO looks to the General to determine the best way to implement the plans to improve profitability and cash flow developed by the CFO in the Strategist role.

Take action on the improvement strategies.

Who relies on the general for leadership? Provide leadership to the CEO and management team and board.

As the financial leader, it’s your duty to make the tough calls. Dan Sullivan, founder of The Strategic Coach, once said, “all progress begins with telling the truth.” Be honest with yourself and others about where you are and where you can realistically go in improving profits and cash flow.

game planCoach

The CFO must also be a Coach. The Coach provides leadership to all stakeholders and puts into play the plans developed by the Strategist that the General feels will be the most likely to lead to success.

All coaches need a playbook. The strategist characteristic of a financial leader develops the plan, the general gets the CEO on board with the plan and the Coach implements the plan with the team. The Coach’s playbook contains many tools to implement these plans such as the flash report, daily cash report, flux analysis, and projections.

Diplomat

Diplomacy is key to financial leadership. Many CFOs don’t realize how many people outside of the company look to them for leadership.

Who relies on your leadership?

The company’s banker relies on the CFO to ensure that the company is in compliance with debt covenants. In addition, the company communicates plans to get back in compliance should problems arise.

Investors rely on the CFO to provide accurate and timely financial information and apprise them of progress towards business goals. Other external stakeholders, including CPA firms, insurance agents, regulatory agencies, etc., also rely on the CFO for leadership.

Oftentimes, the company’s chief investors are your vendors. Vendors look to the CFO to ensure that the company pays its invoices in a timely fashion. This safeguards their source of repayment (assets) should problems arise.

Conclusion

Financial leadership is changing. CFOs of the past relied upon hoards of accountants holed up in a room processing invoices in batches, printing reports on green bar paper and footing the reports with ten-key adding machines. Today’s companies show the “silos” of finance, sales, and operations giving way to an integrated organization. They now have far fewer accountants where transactions are captured live and stored in the cloud.

So how does today’s financial leader cope with these changes? By being a Strategist, a General, a Coach and a Diplomat. Functioning within each of these roles enables the CFO to improve the company’s profitability and cash flow. The CFO also provides leadership to all members of the organization: superiors, subordinates, peers, and external stakeholders. Transform the way you lead your company by becoming an income producer.

Interested in learning a few simple ways you can start improving cash flow today? Click here to download our 25 Ways to Improve Cash Flow to start making a big impact with a simple checklist.

The Strategic CFO

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5 Ways a CFO Adds Value

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How does a CFO add value?

Oftentimes, CEOs don’t see the value in a CFO… They ask “how does a CFO add value?” After hearing that countless times, I want to let you on a little hint.

A good CFO improves profitability and cash flow 1-2% of sales.

A few months ago, I was meeting with a young man named Nathan who was about 8-10 years into his career. Nathan had achieved his dream by becoming the Director of Finance for a mid-size entrepreneurial company. What could go wrong?

Nathan started getting frustrated because the company would not value him as a financial leader. They saw him as overhead. Leadership thought he could do more. They didn’t respect him. The financial leg of the company saw him as a cost centerHave you ever been in the same boat as Nathan?

Very quickly after his promotion to this position as Director of Finance, Nathan began to regret taking the offer.

How do you go from “overhead” to valuable?

Let’s go back to my simple answer: a good CFO should improve profitability and cash flow 1-2% of sales.

Increasing EBITDA

Most CEOs see CFOs as overhead, especially when they don’t make a positive difference to the bottom line, or EBITDA. Before Nathan was promoted to Director of CFO add valueFinance, there wasn’t anyone in a financial leadership position in the company. The company wasn’t financially managed.

In the case that there is no CFO or the past CFO was not successful as improving profitability and cash flow, it is reasonable to expect the new CFO to improve profits and cash flow by 1-2%.

For ease of explanation, we’re going to focus on increasing EBITDA simply because it’s difficult to mitigate interest, taxes, depreciation, and amortization. There are only a few ways to increase your EBITDA: increasing sales, reducing overhead and improving cash flow are some of these.

(Need to improve your cash flow? Download your free 25 ways to improve cash flow!)

It’s often said that the CEO drives sales and the CFO manages everything underneath that! It couldn’t be said more perfectly. But there’s one thing that I don’t necessarily agree with. If the CEO is only managing sales (keep in mind that you have to spend money to make money) and the CFO is managing operations and accounting, there’s an imbalance in financial management.

(Click here to read a case study to price for profit while utilizing the 3-legged stool example you’re going to read about below.)

A 3-legged Stool

CFO add value

You probably figured out now where we’re going with this. A 3-legged stool has… well 3 legs! Each leg is imperative for the seat to stand horizontal. People rely on there being 3 legs so they can rest and sit on the stool.

Sales, operations, and accounting go hand in hand. Revenue allows for the company to continue to operate. Operations fulfills the sales orders. But if you accounting doesn’t manage cash flow, then operations can quickly spend more than is coming in. If cash flow isn’t managed, sales could sell either at a loss or without collecting for x amount of days resulting in no cash.

#1 Reason Why Businesses Fail: No Cash

Cash is king. So if cash is so important, then why are financial leaders not valued?

Typically, companies see financial leaders as the weak link. Others in the organization don’t know their value.

How should financial leaders be valued?

What gets measured gets managed. If you’re not even looking at your records (i.e. historical data), then you’re probably not going to use those numbers to run your business.

A CFO needs to ensure that operations has enough cash to purchase inventory to produce the products that sales needs to sell. If the CFO is not working with the sales force to project sales, then you will easily miss sales targets. Thus, this results in miscalculated inventory levels.  Suddenly, the company is dealing with angry customers and no cash.

In short, the CFO is important. While a 1-2% improvement may not sound like much, a CFO of a $50 million company could add $500,000-$1,000,000 worth of value to the company. The value added in this case will certainly cover their salary and then some.

Just like a CEO can increase his or her salary by increasing the size of the company, a CFO can increase his or her salary by improving profitability and cash flow.  This is typically why the larger the company, the larger the salary. 1-2% of a $50 million company is a lot different than a $100 million company. If you as the CFO are able to add enough value to the company to cover your salary and then some, it’s hard for others to argue that you aren’t valuable.

Case Study

CFO add valueA couple of years ago, I had a client, Rob,  that owned a $135 million distribution company. Over time, Rob has accumulated a massive amount of inventory. When I went to find out where the company was bleeding, I identified that Rob’s cash conversion cycle had jumped significantly over the past 4 year period.

Rob and I were able to free up and reduce his daily sales outstanding (DSO) from 180 days to 90 days. This freed up $4 million in liquidity! By freeing up cash, Rob was able to add value to the company.

This is only 1 of the 5 ways to improve your cash flow that is included in our free white-paper!

If you are seeking to add real value as a financial leader, click here to learn the 5 Ways a CFO Adds Value.

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Business Advisory System

DHS warning systemYou may be familiar with the advisory system (pictured at right) formerly used by the Department of Homeland Security to disseminate information regarding the risk of terrorist acts.  Despite its being replaced by a new system in 2011, most of us remember the color-coded warning system that came in the wake of September 11.

SCFO advisory systemBut, in the midst of a financial crisis (or when planning for a downturn), businesses need to be aware of their surroundings as well. To help companies analyze their environment to determine when action is necessary, we translated the Department of Homeland Security advisory system into the Strategic CFO Business Advisory System.

Best Case

Under the Best Case scenario, you’ve probably projected the crisis to resolve in less than 6 months. In this case, simple frugality might be enough to weather the storm. Generally, no systemic changes are needed to get through the trouble.

Probable Case

As Mr. Murphy would have it, generally Best Case scenario isn’t probable. More likely than not, it will take 6-12 months for the crisis to resolve. The bad news, you’re going to have to make some changes in your processes other than keeping a lid on costs to ride things out.  The good news, this is the most likely situation that you will find yourself in and you can manage it.  At least it’s not the Worst Case scenario…

Worst Case

Under the Worst Case scenario, you probably don’t expect the crisis to resolve within the next year. In fact, you may have no idea how long it will take for things to return to normal. In this case, you’re going to have to make some tough decisions to survive.

What can you do?

You need to create a plan for each of the cases above. What will each case look like with regards to your financials – revenue projections, cash flow projections, etc. How much overhead can you carry in these stages?

How do you know which stage of the Business Advisory System you’re in? This will require some serious evaluation of Key Performance Indicators (KPIs). You’ll need to know major KPIs in your industry.

(NOTE: Need help finding your company’s KPIs? Check out our KPI Discovery Cheatsheet!)

Once you have identified some KPIs, it’s time to track them. Track KPIs and analyze variances. Then you may use trend tools, what-if scenarios, and breakeven analyses.

Monitor where you are on the Business Advisory System month-by-month and be prepared to take necessary steps to ensure that your business is profitable and cash-positive.

Use KPIs to identify what stage of the Business Advisory System you are in.  Create a plan for each stage so that you are ready to act if your KPIs indicate it’s time.

Download our free KPI Discovery Cheatsheet and start tracking your KPIs today!

KPI Discovery Cheatsheet

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Cost Control vs Cost Reduction

cut costs There is a difference between cost control vs cost reduction. Most people think that controlling costs and reducing costs are one and the same when, in fact, they can generate two totally different outcomes.

The first thing you need to know is that you can’t grow a company by cost reduction alone. You can get short term gains but, eventually, they fade. When public companies reduce costs through a restructuring there is typically a  short term lift to their stock price. However, for the increased stock value to be sustainable they must grow revenue.

An example might be Barnes and Noble bookstores. No amount of cost cutting is going to change the situation that they find themselves in today. They must reinvent themselves and pivot.

So if we want to add value we must grow revenue, how do we do it? There are three ways that come to mind. We could develop new products or services, increase market share or increase selling efforts. What do all three of these strategies have in common?

You have to increase costs to increase revenue!

So instead of looking for the lowest cost in a transaction you should look, instead, for the largest value received per dollar spent. It is easy to apply this train of thought to selling costs, marketing costs or product development costs, but what about overhead?

Does hiring the candidate at the lowest salary translate into a good value proposition? Does paying a premium get you a better employee?

The answer is: “it depends”. You should evaluate each cost incurred in light of the excess value received and the goals of your company.

We knew a company who wanted to spend as little as possible on their accounting staff. So they hired the cheapest accountants they could find not the most competent. In the end, they spent more money on cleaning up the financial statements, bringing them current and completing the year-end audit than the savings recognized.

The moral of this story is that you can’t build a house with only a hammer. Consequently, you can’t grow a company profitably by just focusing on cost reduction.

Learn how to apply concepts like this in your career with CFO Coaching.  Learn More

cost control vs cost reduction

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