Fixed costs can be a killer in any business – they can creep into any organisation slowly and choke it like a pervasive weed. Here’s how one specialist suggests you manage these difficult expenses.
Now it may be my accounting background, but one of my biggest fears in business is unnecessary fixed costs. It is a killer of business and the biggest cause of “fire sales” in Australia.
I see many examples of this, where growing organisations start winning new contracts and then the disease is born. Yup, the need to increase fixed costs in the business!
For the non-accountants and non-economists out there, fixed costs can be described as business expenses that are not dependent on the level of goods or services produced by the business.
If you are a management accountant you would probably describe fixed costs as expenses which do not change as a function of the activity of a business within a relevant period.
Now these fixed costs are not necessarily forever but they are costs you typically fix yourself into for a period of time and when business is booming that’s great, we can afford them.
But let’s imagine we are a mining services company which has won some great contracts to provide services to large mining companies. Business is suddenly booming and the bank manager loves us.
Great, I can imagine you are feeling good for this imaginary company, but then suddenly we “screw up on a contract” or the mining company cuts back on a project ,pulls a contract and WHAM. Things don’t feel so great now and the bank manager isn’t as friendly as he once was.
Sound familiar? It should. I meet organisations like this on a regular basis.
So what mistakes were made?
Well during this period of growth everything looked roses so we did some of the following:
- “We leased a fleet of vehicles we are now stuck with and the lease runs out in two years time”
- “The offices we had were okay, however we decided to expand into those plush new offices that cost us four times the rent and we are now stuck with them for a five year lease”
- “We managed to win a small contract in Brazil so we recruited staff and took on an office there and of course we had to provide the staff with leased vehicles. We still haven’t been able to win anymore business there”
- “One of our major customers is disputing $2m dollars worth of work and it may take months to sort this out”
- “We now have 35 administrative staff we need to find wages for and only had nine prior to our expansion”
In business we all need to take calculated gambles as we grow but we need to make these gambles sensible.
Take my pretend example of opening an office abroad based on winning one small contract. Are you really going to rule Brazil or realistically ever going to win another contract there? The answer is we don’t know.
So the sensible thing would be to initially try to work remotely or just use a serviced office! Did you really need to employ staff there or could you have better utilised the increased staff levels back here in Australia? Did you really need to provide them with leased vehicles and mobile telephones on a three year contract?
Monitoring of fixed costs and sensible decision making is critical to your survival.
My recurring nightmare is of businesses that have worked extremely hard to grow and suddenly find themselves not being able to meet their costs. Unfortunately, this is often a reality.
So wake up and please think long and hard before committing your organisation to fixed costs.