Race don't chase
By Ann-Maree Moodie | smh.com.au | 30 May
Slashing the entertainment budget may reduce costs but it won't necessarily improve revenue.
There is an accounting maxim for everything and in a recession the most sage piece of advice is "race don't chase" meaning to cut expenditure faster than revenues decrease.
"If you simply chase revenues to the bottom of the curve, economic theory tell us that you will spend every month of the recession losing money," says Mark Horstman of podcast Manager Tools. "If your expenses drop faster than your revenues, you can do the apparently impossible make money in a down market."
This type of deep cutting is certainly going to please the boss but will it be right for the profitability of the business in the long term?
It sounds like a simple piece of advice, especially when your boss is screaming for another 5 per cent, 10per cent or 20 per cent slice off the expense line in your budget. Activities such as travel, entertainment and marketing are traditionally first to go because they're deemed "discretionary" expenditure and therefore easy to "give up".
But Nigel Finch, a senior lecturer in accounting and finance at the Macquarie Graduate School of Management in Sydney, says a savvy manager will look more closely at the numbers and be less quick to cut discretionary items.
"It's a dangerous philosophy in financial management to cut expenditure willy-nilly because it can lead to greater erosion in profits," says Finch.
"The idea is to reduce operating expenditure with a view to improving profitability. But if we cut the wrong expenses, then more than likely profitability will continue to decline and it won'thave the effect that we're looking for."
The more rational and better informed manager will identify the costs that drive revenue. For example, it's common to view a sale representative's salary as an expense that's easy to cut. But if thatperson is the top income producer, they have immense worth. If they're retrenched, your capacity to sell as effectively will be greatly diminished.
"Rather than having a knee-jerk reaction and just trying to reduce expenditure across the board, it's better to invest some time in planning what types of costs you'reprepared to cut and what areas you're not prepared to cut oreven to continue to invest in," says Finch.
The idea is to start at the outcome and work backwards. Instead of slashing the travel budget, look at where travel is beneficial. If some of the firm's biggest clients are located inter-state, then continuing to visit regularly is a prudent idea. But irregular travel to other cities to drum up business is a less certain venture and the return on the investment less likely.
"Part of becoming a better manager is identifying the non-financial drivers in our business and communicating those to others in the firm that shows a level of leadership," he says.
Price is an example of a value driver for a product or service. Let's say an expectation of quality allows the company to charge a premium. Amanager should then ask, if quality drives price, what drives quality? What is it that we do that drives quality? Isit consistency? Reliability? Timeliness? Questions such as these will unlock the reasons why it's appropriate to spend money and determine how to extract a higher price from the customer for a product or service.
Another way to identify value drivers in the business is to rename the expenses to reflect their relationship to business outcomes. Instead of "travel", "entertainment" or "newsletter", call them "customer acquisition activities" or "customer retention activities". By renaming the expense items as business activities, it's easier to work out what the expected returns are for each activity and whether they should be continued, or abandoned because the pay-off is lower. Essential to this type of analysis is real-time data to show whether the budgeted expense ismore than well spent by the actual return.
In this climate it's a brave (if not naive) manager who resists demands from the boss to cut expenditure. Chances are the budget targets will be met by way of them losing their job.
Accountant and author William Webster says the key to becoming a successful manager is to start thinking like an owner.
"As a manager, your prime duties include asking questions about all the things that your entity needs to do the job and how much each costs," he says.
By being less reactionary and analysing the best way to achieve that 20 per cent cost reduction, your budget will not only meet the dictates of management but your department may well return a profit. Now that's a way to keep your job.
First published by Smh.com.au on May 30 2009
Visit smh.com.au for the latest news updated throughout the day
