First published in the Financial Times on 11th November 2014.
As businesses prepare their annual budgets they should not become blinded by sales growth
Governments and political parties can be broadly divided into those which believe it is their duty to carry out more and more public spending, and impose ever higher taxation (and take on ever more borrowings) to pay for their largesse; and those which focus on cutting spending and tax, and achieving better value for citizens. Ultimately the former administrations drive countries bankrupt, and immiserate taxpayers – because their priorities are wrong.
Similarly, I have found that companies fall in to one of two categories: those whose efforts are mainly directed towards increasing the top line, with little emphasis on costs; and those which understand that higher revenues are all very well, but know that controlling expenses is actually the secret to delivering a decent bottom line.
I am acutely aware of this distinction at present. Most companies on whose boards I sit are grinding through the annual budget process, and trying to project 2015’s results. In doing so, organisations reveal their biases. Too many management teams are satisfied with a performance which is “good enough”: having been through a long recession, they are content with modest margins and returns. But feeble profitability means fewer resources for investment, diminished rewards for all stakeholders, and an impaired ability to withstand external shocks.
Growth can be a marvellous phenomenon – more jobs, greater scale, new products – all laudable aims for any business. But if increases in sales become an overwhelming objective, and expenses are neglected, then normally grand plans run aground.
Too often more sales are seen as the antidote to everything. It allows leaders to forget what they see as the drudgery of addressing bloated costs. Unfortunately, growth usually consumes cash in working capital – and if profits are anaemic, then the cash runs out.
There are always a thousand excuses as to why costs cannot be cut. Managers are too embarrassed to ask for lower prices from suppliers; they are too squeamish to make surplus workers redundant; they lack the resolve to challenge how money is spent; they are comfortable with the status quo; they are too lazy to examine in detail where expenses arise, and find intelligent ways to reduce them; and they are too scared of losing customers to re-engineer products so as to generate a fair return.
Costs come in every shape and size, from travel and office equipment to software and utility bills. An attitude of mind should be developed which questions every line, every contract, and every quoted price. Small items can add up to big numbers. More can almost always be done with less, if circumstances require it. Waste does not simply damage financial outcomes; it is a moral issue.
While I dislike being involved in companies which labour under tough bank covenants, they do have one benefit: they force managers to take hard decisions about excessive costs, unneeded overhead, and lavish spending. Similarly, companies in crisis learn that almost everything is negotiable. Expert turnround bosses are masters at cost-cutting. They know that a successful war on costs is always a better outcome than liquidation. By contrast, companies which sit on piles of cash almost never examine capital expenditure proposals with as much rigour as they should – and that is how they come to misallocate funds.
The reason why most companies have to be unsentimental and even mean about expenditure is that they operate in highly competitive sectors: few have the luxury of powerful patent protection, a legal monopoly or compelling brands. They slug it out for market share and engage in hand-to-hand combat every day.
But even ordinary companies can win through determination and stretching themselves. Strong businesses make productivity and efficiency an overriding imperative; it becomes embedded in their culture, from top to bottom. Employees learn to be creative and forceful in eliminating extravagance and surplus. They realise that few costs are cast in stone, and that being adaptable over outlays means a more prosperous, enduring future. No one should feel guilt about cutting costs, or finding cheaper ways to do things. Every entrepreneur should be proud to be frugal.
Governments and political parties can be broadly divided into those which believe it is their duty to carry out more and more public spending, and impose ever higher taxation (and take on ever more borrowings) to pay for their largesse; and those which focus on cutting spending and tax, and achieving better value for citizens. Ultimately the former administrations drive countries bankrupt, and immiserate taxpayers – because their priorities are wrong.
Similarly, I have found that companies fall in to one of two categories: those whose efforts are mainly directed towards increasing the top line, with little emphasis on costs; and those which understand that higher revenues are all very well, but know that controlling expenses is actually the secret to delivering a decent bottom line.
I am acutely aware of this distinction at present. Most companies on whose boards I sit are grinding through the annual budget process, and trying to project 2015’s results. In doing so, organisations reveal their biases. Too many management teams are satisfied with a performance which is “good enough”: having been through a long recession, they are content with modest margins and returns. But feeble profitability means fewer resources for investment, diminished rewards for all stakeholders, and an impaired ability to withstand external shocks.
Growth can be a marvellous phenomenon – more jobs, greater scale, new products – all laudable aims for any business. But if increases in sales become an overwhelming objective, and expenses are neglected, then normally grand plans run aground.
Too often more sales are seen as the antidote to everything. It allows leaders to forget what they see as the drudgery of addressing bloated costs. Unfortunately, growth usually consumes cash in working capital – and if profits are anaemic, then the cash runs out.
There are always a thousand excuses as to why costs cannot be cut. Managers are too embarrassed to ask for lower prices from suppliers; they are too squeamish to make surplus workers redundant; they lack the resolve to challenge how money is spent; they are comfortable with the status quo; they are too lazy to examine in detail where expenses arise, and find intelligent ways to reduce them; and they are too scared of losing customers to re-engineer products so as to generate a fair return.
Costs come in every shape and size, from travel and office equipment to software and utility bills. An attitude of mind should be developed which questions every line, every contract, and every quoted price. Small items can add up to big numbers. More can almost always be done with less, if circumstances require it. Waste does not simply damage financial outcomes; it is a moral issue.
While I dislike being involved in companies which labour under tough bank covenants, they do have one benefit: they force managers to take hard decisions about excessive costs, unneeded overhead, and lavish spending. Similarly, companies in crisis learn that almost everything is negotiable. Expert turnround bosses are masters at cost-cutting. They know that a successful war on costs is always a better outcome than liquidation. By contrast, companies which sit on piles of cash almost never examine capital expenditure proposals with as much rigour as they should – and that is how they come to misallocate funds.
The reason why most companies have to be unsentimental and even mean about expenditure is that they operate in highly competitive sectors: few have the luxury of powerful patent protection, a legal monopoly or compelling brands. They slug it out for market share and engage in hand-to-hand combat every day.
But even ordinary companies can win through determination and stretching themselves. Strong businesses make productivity and efficiency an overriding imperative; it becomes embedded in their culture, from top to bottom. Employees learn to be creative and forceful in eliminating extravagance and surplus. They realise that few costs are cast in stone, and that being adaptable over outlays means a more prosperous, enduring future. No one should feel guilt about cutting costs, or finding cheaper ways to do things. Every entrepreneur should be proud to be frugal.