Why Businesses Fail: Understanding the True Cost of Doing Business
Running a business comes with a multitude of expenses that aren't directly tied to your product or delivery of service, yet are essential for keeping the business running. These are known as your "costs of doing business". While they may seem stable and manageable when revenue is strong, they can become a significant liability when growth slows or, worse, when revenue declines.
Defining The Cost of Doing Business
When talking about the "cost of doing business", we're referring to all the expenses that remain constant, regardless of revenue fluctuations. Unlike variable costs, which move in tandem with sales volume (think raw materials, labour specific to production), costs of doing business tend to stay the same whether you're generating a high or low revenue.
Example expenses might include:
- Rent and Utilities: Office rent, electricity
- Operational Essentials: Accounting fees, legal fees, IT support
- Marketing and Advertising: Website hosting, social media advertising
- Insurance and Compliance: Liability insurance, regulatory fees
- Employee-related Expenses: Salaries for administrative staff, HR
Key Takeaway: While it's easy to overlook these as fixed background costs, they can and will quickly add up (especially if left unchecked), undermining profitability.
Differentiating Between Fixed and Variable Overheads
- Fixed vs Variable Costs: While the cost of doing business is often considered "fixed", it's worth distinguishing between costs that are strictly fixed (think long term leases, certain insurance premiums) and those that have some flexibility (think utilities, or software subscriptions that may scale with usage and implementation)
- Cost Management Flexibility: Identifying costs that could be reduced or optimised during leaner periods (without impacting service delivery) can provide a valuable buffer during economic downturns.
How Cost of Doing Business Can Lead to Financial Strain
So, how can these costs put your business at risk? Let's look at some example scenarios:
1. Growth Stalls or Revenue Contracts
When a business grows, it's only natural to increase spending to support that growth (think spending on infrastructure, people, facilities, etc.). However, if the same business then hits a plateau, or even worse, contracts, those costs will still remain. This will become especially problematic with long-term commitments, such as multi-year office leases or permanent hires, as these aren't easily reduced.
2. Incorrect Breakeven Calculations
When businesses fail to accurately understand their breakeven point many challenges will come to light. Let's work through it - if your breakeven point is the revenue needed to cover all costs (including taxes, debt repayments, and owner's drawings), and your understanding of this figure is inaccurate, you're going to have problems. Your revenue will cover your gross profit, but not the entire cost of doing business - you're going to have a cash flow squeeze. Over time, this can lead to mounting debt and further cash flow problems.
3. Poor Decision-Making Without Breakeven Insights
Making large investments in equipment, personnel, or property without understanding the impact on breakeven can jeopardise a business. Business owners often add costs during growth periods but may not calculate how these will affect the business if sales fluctuate. Having a clear, accurate breakeven is essential for any significant investment decision.
Real-World Example: The Breakeven Relief
A common example CFO Dynamics sees, when working as a Virtual CFO service provider, is with business owners who believe their breakeven is lower than it is (as in, they think their costs are lower than they are). In one case, a client thought their breakeven was at $4 a unit, only to find out, through careful calculation, that it was closer to $5. This revelation clarified as to why their cash flow was perpetually tight, despite reasonable gross margins. By understanding the true cost of doing business, they were able to put in place a strategic plan to reduce overheads and increase revenue, ultimately improving cash flow.
Actionable Steps to Manage the Cost of Doing Business
To keep your business financially healthy, you need to take proactive steps in managing your cost of doing business. Here are a few Dynamic recommendations:
1. Ensure Your Breakeven Calculation is Accurate
- Review monthly: Calculate breakeven every month, including every element - taxes, debt repayments, owner's drawings, and operational overheads.
- Use trusted data from your finance team: Make sure your finance team provides you with an accurate, up-to-date breakeven figure.
2. Consider the Impact of Every Major Investment
- Evaluate the "Three P's": Assess how investments in people, plant (equipment), and property will affect your break-even.
- Sustainable hiring: While it can be tempting to add headcount during growth periods, it's crucial to weigh long-term sustainability. Options such as contract or part-time workers can provide the needed flexibility without committing to full-time salaries and benefits.
- Run worst-case scenarios: Before committing, ask yourself, 'What would happen to our breakeven if revenue dropped by 20-30%?
3. Regularly Review and Reduce Non-Essential Expenses
- Evaluate ongoing contracts: Review any and all long-term commitments regularly and look for negotiations. Designate this role within your finance team for monthly check ins.
- Challenge unnecessary costs: Distinguish between "nice to have" expenses and essential expenses. Streamlining theses can improve your overall business profitability, without impacting core operations.
- Regular budget reviews: A rolling budget enables the business to reassess costs monthly or quarterly, adjusting based on performance and future projections. Annual budgeting may not respond quickly enough to fluctuating revenues.
4. Be Cautious During Growth Phases
- Avoid impulsive spending: Growth can often encourage spending on non-essential items, (think luxury office spaces or high-end perks). Stick to investments that drive business profitability and directly improve business value.
- Plan for market fluctuations: Assume that growth may slow down at some point, plan for how you would adapt your costs accordingly. There is no need to implement the plan until it's actually required, you don't need to be spending resources and distracting from current growth goals - you just need to be ready to react if it comes to it.
Optimising Resource Utilisation
- Assessing Productivity and Capacity: For costs related to employee salaries, facilities, or equipment, it's crucial to evaluate whether the resources are being fully utilised. For example, a business might have additional office space that it no longer needs, or an under-utilised piece of machine that could be sold or rented out.
- Cross-Training Employees: Cross-training can be an effective strategy to make better use of employee skills during periods of low workload, ensuring that existing human resources are maximised without needing to add extra headcount.
Reducing Financial Strain with a Virtual CFO
A Virtual CFO brings a level of financial insight and strategic guidance that goes beyond traditional bookkeeping. By aligning costs with growth, implementing cost-cutting strategies, and enforcing financial discipline, a Virtual CFO will help reduce the strain of fixed expenses, allowing the business to grow sustainably. With this proactive approach, businesses can make confident, data-driven decisions that keep overheads in check and profitability on track. If your business is ready to take control of the cost of doing business, a Virtual CFO can provide the expertise you need.
How a Virtual CFO Impacts the Cost of Doing Business
For many businesses, engaging a Virtual CFO is a strategic way to gain high-level financial expertise without the substantial costs associated with a full-time CFO. A Virtual CFO provides vital financial guidance but also helps to actively manage and optimise the cost of doing business. Here's how CFO Dynamics can make a measurable impact as your Virtual CFO:
1. Providing Accurate Breakeven and Profitability Insights
- Setting a true breakeven point: One of the first actions we take is calculating an accurate breakeven point. By including all fixed and variable costs, taxes, debt, and owner's drawings, we ensure your business understands the exact revenue target required to cover all expenses.
- Ongoing profitability analysis: As your Virtual CFO we provide continuous monitoring of profit margins to ensure that both gross and net profits align with your company's goals. This insight will allow you, as the business owner, to make proactive adjustments before overheads outpace revenues, always safeguarding your cash flow.
2. Identifying Cost-Cutting Opportunities Without Sacrificing Quality
- Analysing overhead expenses: A Virtual CFO takes a close look at operational expenses, identifying key areas where costs could be reduced without compromising quality or productivity. It might include renegotiating contracts, finding alternative suppliers, or automating routine tasks to cut down on administrative hours.
- Improving resource allocation: By examining under-utilised resources - such as unneeded office space, unused equipment, or redundant software - at CFO Dynamics we can recommend ways to either reduce or better use existing assets, lowering the overall cost of doing business.
3. Forecasting and Preparing for Growth-Related Costs
- Managing sustainable growth: While business growth often brings additional costs, as your Virtual CFO, we help ensure these expenses are manageable and justified by expected returns. We can forecast the impact of new hires, technology, or facilities on your overall costs, balancing growth ambitions with cash flow sustainability.
- Strategic scenario planning: With our experience in scenario modelling, CFO Dynamics can help prepare your business for unexpected shifts, such as market downturns, by mapping out how different revenue scenarios affect costs. This way, your business can react quickly and avoid prolonged periods of high expenses in low-revenue conditions.
4. Ensuring Data-Driven Investment Decisions
- ROI analysis for major expenses: Before committing to any significant investments, a Virtual CFO will evaluate potential returns and how these expenses will impact the true breakeven threshold. Your investments need to be strategically sound and financially viable and sustainable.
- Mitigating risk: The Virtual CFO will also assess how each major decision - be it people, property or plant - will affect both short- and long-term cash flow. It ensures that decisions are financially sound even in cases of slower-than-expected revenue growth.
5. Improving Cash Flow Management and Cost Discipline
- Cash flow optimisation: A Virtual CFO will implement cash flow strategies that improve liquidity, such as optimising accounts receivable and payable cycles. This stabilises cash flow, making it easier to cover fixed costs and invest in growth.
- Enforcing financial discipline: With CFO Dynamics oversight, your business will adopt a more disciplined approach to spending, ensuring that costs align with actual performance and strategic priorities. This proactive oversight reduces unnecessary expenditures, helping to stabilise the cost of doing business over time.
Conclusion
In essence, a Virtual CFO service empowers a business to optimise its cost structure, remain agile in pricing, and protect its profitability. With the guidance of CFO Dynamics, businesses gain a sustainable, growth-focused approach to costing, keeping margins intact and position themselves for long-term success.
Ready to put your business on track? Take a closer look at your cost structures today. If you're unsure of where to start, a Virtual CFO consultation can provide clarity and a path forward. Get in touch with us to explore how to future-proof your costing practices and ensure sustainable profitability.
Subscribe to our newsletter
For more tips on increasing revenue and profitability, sign up to our newsletter for business owners, leaders, and finance team managers. Each week, you'll get practical, no-fluff tips and insights in short, easy videos. No corporate jargon, no time wasting. Sign up now.
