Now that you’ve gained a clear view of cash coming in versus cash going out, and the timing associated with that inflow and outflow, it’s time to dig deeper into the nature of your revenue.
As we like to say at the beginning of our Managing Your Money podcasts, money makes the world go ‘round, and it makes your business move forward. Hopefully, every month after opening your doors for business, you’ll have sales. But those transactions come with a price, or better said, “a cost.” Just as your business takes in money from what you offer, it incurs costs to make that offering possible.
What we’re focusing in on here is the difference between “revenue” and “net income.”
You may have a sales forecast for the sale of a certain product, but that information does you little good without knowing how much it’s going to cost you to achieve those revenues. For example, how much are you really taking in on a transaction after marketing, development, commissions, or hard product costs?
Managing and maneuvering these costs is as important to your success as the revenue you take in. After all, who cares how much you make – it’s all about how much you keep.
Fixed vs. Variable Costs
Fixed Costs = expenditures that are always and unavoidably there every month
Variable Costs = things you spend on only by choice or as a result of sales
Fixed costs include things like rent, telecommunications, salaries, interest payments, anything that is a constant. Frankly, it’s the stuff that’s easy to plan around because it’s steady – always there for you to have to pay. In any venture, from tiny little you to the biggest behemoths in industry, it’s always desirable to keep fixed costs as low as possible. The fact that you have to pay them is the problem. Even if you have a bad month of revenue, money to pay fixed costs must still be doled out.
As the name implies, there’s not a lot of flexibility when it comes to fixed costs. That’s why, whenever possible, you want to shift your costs to the “variable” category. Variable costs are those that do have some flexibility. If your sales go down, you can quickly react by reducing variable spending.
To demonstrate how to think about fixed versus variable costs, take this example: Instead of hiring a secretary as an employee, consider outsourcing to a contract worker such as a virtual assistant. That way, a) you use only the hours you can afford to at any given time, and b) you don’t have to commit to office space necessary to accommodate that employee. If revenue plummets, scale back hours of out-sourced support. If revenue spikes, ramp back up to the ideal level of support.
Here’s another one: Instead of renting a dedicated warehouse facility to house your inventory, find a warehouse company that will allow you to use “flex space,” where you pay only for the space you use. This way, if your business is seasonal, you only carry the cost of the necessary level of warehousing.
Basically, if possible, reduce your fixed costs to the lowest possible level, and put as many line items in the variable category as you can. The more nimble your business is on the spending side, the more likely you are to preserve cash.