When you first launch your business, there is so much to consider. You may be overwhelmed in the beginning; however, once you get the ball rolling, things will calm down a bit. Granted, as a business owner or entrepreneur, you’ll always have what seems like a never-ending to-do list. But as time goes on, it is time to start analyzing your business practices. Taking a closer look at how you are running things will help you make changes before any issues get out of hand. Obviously, if you want the business to continue, you need to be making money. While you are analyzing your business practices, it can be helpful to determine if all of your methods are truly getting you the most bang for your buck, so to speak. Evaluating a business can be tricky, depending on the business’s size, capital structure, goals and the prevailing market environment. What follows is a summary of several analytical tools a business owner or other interested parties could use to determine whether or not a business is cost-effective.
Operational Profit per Sale
One of the first things to look it is how much profit you are making per sale, whether you are selling products or services. It helps to measure net operating profit per sale with separate categories for different services/products. An early-stage business may not be profitable overall, but if each sale brings in more than it costs, that’s a good trend. Exclude unusual and infrequent expenses.
Credit and Interest Rates
Applying for debt will give an idea of how reliable creditors perceive your business to be. Of course, “reliable” is short-hand for “cost-effective for the duration of the loan.” If similar-sized competitors are getting lower interest rates for similar borrowing terms, your business may not be as cost effective as you think.
Cost-effectiveness implies an ability to nimbly respond to changing market conditions. For example, consider a business that has tremendous profit margins but operates via bulky long-term obligations and specialized heavy equipment. If faced with fast-paced new market conditions, ability to invest in new ventures or control expenses would be compromised. To sell inventory quickly, it would have to agree to a price far below book value and/or suffer the loss of market share as consumers and clients go elsewhere.
When you launched the business, you were well aware of how much every little thing was costing you. You knew exactly how much it would cost to design and produce your product, maintain your machinery, dispose of any waste related to your business practices, etc. However, as time goes on, what you once paid for these things might not be the right price for you anymore. It is good to evaluate how much you are paying for the management of your assets because those prices will also affect how much you are charging customers or how much you can pay employees. Improving asset management practices can help companies provide better service to clients, and will ensure that your money isn’t being wasted unnecessarily.
Revenues per Variable and Fixed Cost Dollar
A cost-effective business may in fact increase variable and/or fixed cost if the corresponding revenue gain is worth it. Variable costs have to be manipulated in light of the fact that marginal returns tend to decrease with more and more product/service units sold, putting a cap on even the best variable-cost investments.
Businesses need to know the value of their advertising. If this metric is not clear, pull back on advertising. Even if revenues fall, the business owner will then have some data to correlate with each added or subtracted advertising dollar. This enables the business manager to make much better advertising decisions than are made by chasing the latest trends like “social media” or “engagement.” It may take a while to find the most cost-effective way to market to your specific audience, but it is important that you don’t waste valuable money on campaigns that aren’t working.
The previous list of variables is not extensive or all-encompassing. However, all stress segmented and quantifiable metrics that have an intuitive, fundamental link to the immediate economic environment. These are the kinds of metrics that will give you a good idea of how hard your money is working for you. It is no secret that funds are extremely limited in the first few years of a business. However, even when your business starts to boom, be sure to constantly analyze where the money is going and whether or not your expenditures are worth the asking price. Critically examining the cost-effectiveness of your business will allow you to save money when funds are low, giving you a greater chance of growing your business in the future.
Author: This article was written by Dixie Somers, a freelance writer who loves to write for business, finance, women’s interests and technology. Dixie lives in Arizona with her husband and three beautiful daughters.
Small Biz Club is the premier destination for small business owners and entrepreneurs. To succeed in business, you have to constantly learn about new things, evaluate what you’re doing, and look for ways to improve—that’s what we’re here to help you do.