The Credit Crunch IV: Business profitability

7 August 2008

Survey after recent business survey has painted the same unfortunate picture of the UK economy.

For example, the latest CIPS index of trading conditions for the services sector, the driving force of the economy, eased up slightly in July to 47.4 from the seven-year low of 47.1 recorded in the previous month. An improvement if only in that the sector is contracting at a slightly slower rate. Also in July, the manufacturing sector saw 0.5 per cent shaved off its output, the fourth month on the trot it has fallen.

Businesses are beleaguered on the one side by the credit crunch – customer money in tight supply – and on the other by rising prices – supplier costs on the rise. Squeezed between them is that most vital of all business statistics: profit margins.

It may seem odd, when businesses are busy worrying about looming recession (the British Chambers of Commerce has warned of the possible imminence of two successive quarters of negative growth), spend-shy customers, evaporating credit, expensive borrowings and late payments, to give priority to profitability. But it is profitability that keeps a balance sheet healthy; and profitability that means a business is best equipped to come through the buffeting winds of the credit crunch. In other words, make sure that your business has that most craved of commodities – surplus cash.

In two essential respects, maintaining profitability in a time of economic difficulty is no different to maintaining profitability under any other trading conditions. A business either looks to boost its sales income or to cut its direct costs.

Sales

To fuel sales, a business, as ever, should keep an eagle eye on its market and its competitors. Products and services must meet the demands of one and stay ahead of the other. It is important not to let service standards slip (deliveries made on time and to the right specification): if customers are more reluctant to spend, don’t give them the excuse to leave you because you are failing to live up to past quality of service. Remain flexible, agile and, wherever possible, innovative.

Confronted by a tightening market, it may be tempting to cut prices to attract more custom. Think long and hard about this. Will the consequent fall in profit be more than compensated for by an increase in sales volumes? Remember, too, that when the credit crunch has finally abated, you may find yourself having to push up prices by above-inflation amounts.

Your prices, of course, need to cover both the fixed costs (rent, wages) and the variable costs (energy, transport) incurred by your business. But also bear in mind that your customers may well see your product or service as adding a value to them. Even during tough trading conditions, the value of your service may be such that customers will still be willing – may be even more willing – to pay for the extra benefits you bring such as reliability and excellence of product.

Overheads

Looking for ways to reduce your costs should always be an imperative. During the credit crunch, it has become a matter of greater importance.

Expenses

Scrutinise all your expenses, including those of your staff, and look for ways to trim them without imperilling the efficiency or quality of your business.

Wages

One of the worries of the Bank of England is that consumer price inflation will prompt wage inflation, adding oil to the flames of the rising cost of living. With inflation nosing up above the 4 per cent mark, driven by rocketing energy and food bills, it is understandable that employers are casting a concerned eye at wage demands.

The evidence so far suggests that wage inflation is holding within acceptable limits. But many employers will be asking themselves if their business can afford 4 per cent wage settlements.

Wages are often a firm’s largest overhead. An employer must balance the need to keep labour costs manageable while also offering the sort of pay that attracts good, skilled recruits, and that motivates and encourages loyalty among existing employees.

While inflation and the chronic skills shortage the labour market is still experiencing may be pressurising pay, there are measures smaller firms can introduce to soften the impact of their wage bills without hampering their performance.

The first is to make sure that employees are working as efficiently as possible, which means you may not have to take on that extra recruit you have been advertising for. Review your working practices for duplication of tasks. Staff duties can be re-allocated to make better use of the skills and talents of the workforce.

Think about cutting down on overtime bills by employing a part-time worker (this can often be less costly and more productive). Where there is overtime, make sure it is approved beforehand.

It is also important to bear in mind that not all employees are going to be equally motivated or incentivised by financial rewards. Increasing numbers of employers are recognising that other rewards, such as training, regular consultations and flexible working patterns, are just as effective methods of encouraging staff loyalty as bonuses and pay offers.

Marketing

Often the first cost to be cut in a downturn is the marketing budget. Consider, however, the possible positive effects on your sales if, while your competitors vanish from view because they believe that advertising their products and services is simply not worth the cost, you continue to invest in promoting your own business. Slashing marketing budgets can be counterproductive.

Outsourcing

Equally compelling during periods of economic challenge is the urge of managers and owners to devote all of their time and energies to the day-to-day concerns of running the business. Time and energy that might more profitably be spent planning and considering longer term strategies.

A number of business functions can be outsourced. Outsourcing not only frees up resources within the business, it allows you to tap into the expertise of specialist firms and to save money too.

You may, for example, wish to talk to us about outsourcing your payroll and additional accounting tasks. Other areas where outsourcing could be a cost-saving solution include human resources (recruitment, training) and marketing.

Before handing certain operations over to an outside business, however, you will need to consider whether they can offer an appropriate service and have sufficient knowledge of your type of business. Just as importantly, you will need to calculate whether the fees they charge, along with the service they deliver, represent a measurable cost saving.

Suppliers

Put your purchasing policy under the microscope. To investigate if supplier costs can be cut in any way, compile a list of all the businesses you buy from and work out how much is being spent on everything from paper clips to vehicles. Then contact your suppliers to find out if, say, bulk purchases or long-term custom entitle you to discounted rates (even a 5 per cent reduction on stationery can amount to a considerable saving across the year). If they don’t, examine alternatives. The better your relationship with your suppliers, the more amenable they may be to discuss improved deals.

As valuable as price, of course, is the level of service and quality of product suppliers deliver. Opting for a cheaper competitor may not save you anything if the replacement product is not as good and impinges on the performance of your own business. So when reviewing your suppliers, it is vital to take service levels (are they reliable, are they responsive, do they mesh well with your own services, products and ambitions?) into account as well.

Energy efficiency

One area where all businesses, large and small, can reduce costs is energy use.

Many energy efficiency measures are easy to implement. These include using energy-saving light bulbs; turning off radiators that are heating empty rooms or unused areas; placing thermostats in temperature constant positions; setting the hot water supply at 60 degrees (any higher is wasteful, any lower can encourage legionella); fitting draught excluders; improving insulation; making sure that delivery doors are opened and closed only when necessary during colder months; keeping office furniture away from radiators so that the heat distribution is not blocked; and maintaining equipment so that it runs efficiently.

Equipment that can be shut down, like photocopiers and air conditioning units, should be switched off when - overnight and at weekends - there is no one in the office. Some machines or equipment can be moved to a sleep or standby mode, which consumes less power, when not in use. It should be explained to members of staff which switches control which facilities, and they should be encouraged to turn off lights or equipment when rooms are no longer occupied.

Simplicity is the key to ensuring that everyone in a firm plays their part in preventing energy waste. The more straightforward the energy-saving policy that a business introduces, the more likely it is that employees will observe it.

More information and advice on saving energy is available from the Carbon Trust website at www.thecarbontrust.co.uk

Waste management

Managing waste efficiently can help save a business money too. Waste management covers everything from raw materials to technology, from water to sheets of paper.

While manufacturing firms are most obviously affected, all businesses can benefit from having a waste management policy in place. There are waste issues in most areas of business operation, whether it is something as simple as the invoicing system or something more complex like product design.

It is good to begin with the easiest areas in which to make changes. This could involve recycling more paper in the office, or ensuring that electronic filing does not lead to the printing of unnecessary hard copies of documents.

Then tackle the use of utilities, such as water, the way in which raw materials are managed, plant and equipment, working practices and waste disposal methods.

More details on better waste management are available at www.envirowise.gov.uk

If you would like professional help and guidance in boosting your profitability, please don’t hesitate to contact us.