Cost reduction is not simply attempting to slash any and all expenses unmethodically. The owner-manager must understand the nature of expenses
and how expenses inter-relate with sales, inventories, cost of goods sold, gross profits, and net profits.

Cost reduction does not mean only the reduction of specific expenses. You can achieve greater profits through more efficient use of the expense dollar. Some of the ways you do this are by increasing the average sale per customer, by effectively using display space and thereby increasing sales volume per square foot, by getting a larger return for your advertising and sales promotion dollar, and by improving your internal methods and procedures.

Profit is in danger when good merchandising and cost control do not go hand in hand. A big sales volume does not necessarily mean a big profit, as one retailer, Carl Jones, learned.

Jones's pride was stocking stylish and well assorted lines of merchandise. Each year, sales volume increased. This increase was attributed to good merchandise which Jones felt took care of the steady rise in expenses.

Your goal should be to pay the right price for prosperity. Determining that price for your operation goes beyond knowing what your expenses are. Reducing expenses to increase profit requires you to obtain the most efficient use of the expense dollar.

Look, for example, at the payroll expense. Salesclerks are paid to sell goods, and their productivity is the key to reducing the payroll cost.

If you train a salesclerk to make multiple sales at higher unit prices, you increase productivity and your profits without adding dollars to your payroll expenses. Or, if four salesclerks can be trained to sell the amount previously sold by seven, the payroll can be cut by three persons.

Sometimes you cannot cut an increase item. But you can get more from it and thus increase your profits. In analyzing your expenses, you should use percentages rather than actual dollar amounts.

For example, if you increase sales and keep the dollar amount of an expense the same, you have decreased that expense as a percentage of sales. When you decrease your cost percentage, you increase your percentage of profit.

On the other hand, if your sales volume remains the same, you can increase the percentage of profit by reducing a specific item of expense. Your goal, of course, is to do both: to decrease specific expenses and increase their productive worth at the same time.

A useful method for making expense comparisons is break-even analysis. Break-even is the point at which gross profit equals expenses. In a business year, it is the time at which your sales volume has become sufficient to enable your over-all operation to start showing a profit.

Once your sales volume reached the break-even point, your fixed expenses are covered. Beyond the break-even point, every dollar of sales should earn you an equivalent additional profit percentage.

Your profit and loss (or income) statement provides a summary of expense information and is the focal point in locating expenses that can be cut. Therefore, the information should be as current as possible. As a report of what has already been spent, a P and L statement alerts you to expense items that bear watching in the present business period. If you get a P and L statement only at the end of the year, you should consider having one prepared more often. At the end of each quarter might be often enough for some firms. Ideally, you can get the most recent information from a monthly P and L.

Regardless of the frequency, for the most information two P and L statements should be prepared. One statement should report the sales, expenses, profits and/or loss of your operations cumulatively for the current business year to date. The other should report on the same items for the last complete month or quarter. Each of the statements should also carry the following information:

(1)  this year's figures and each item as a percentage of sales.

(2)  last year's figures and the percentages.

(3)  the difference between last year and this year - over or under.

(4)  budgeted figures and the respective percentages.

(5)  the difference between this year and the budgeted figures - over and under.

(6)  average percentages for your line of business (industry operating ratio) when available, and

(7)  the difference between your annual percentages and the industry ratios - under or over.

This information allows you to locate expense variation in three ways: (1) by comparing this year to last year, (2) by comparing expenses to your own budgeted figures, and (3) by comparing your percentages to the operating ratios for your line of business. The important basis for comparison is the percentage figure. It represents a common denominator for all three methods. When you have indicated the percentage variations, you should then study the dollar amounts to determine what line of operative action is needed.