I have been pleasantly surprised of late to speak with business owners who understand the impact of fixed versus variable costs.
A fixed cost is one that must be paid each and every month regardless of how well the business is doing. This applies to all debt, mortgages, salaried employees, equipment loans, leases and rent.
Variable costs as you may judge from the name vary with the volume of business. So, goods for resale, supplies, hourly paid employees, mileage and fuel will grow rapidly with an expansion of the business.
In good economic times, it makes sense to lock down your expenses each month so that you know exactly how many dollars must come in to cover the “nut”. In slowdowns, fixed costs will put you out of business.
In the late 1990s I was part of the senior management team of a “job shop” contract manufacturer for the high tech industry. When we lost three customers during the dotcom bust, the team voted to workshare, cut prices and try and survive. I advocated, keeping up prices but was overruled. The company survived but in a weakened state. During the next downturn when a further three customers moved to the US, the owner changed his tactics by cutting fixed costs, giving up a building, cutting staff and holding his prices. The result was that the company was awash in money – enough to pay cash for new plasma cutters that filled his building. When business returned, he was equipped to handle the extra work, could operate all three shifts and had the cash to withstand the strain of growing receivables.
The lesson to be learned that can be applied in the current business slowdown is:
- Don’t add any further fixed costs burden to the company.
- Cut all variable costs where you can.
- Don’t cut prices and follow the crowd heading over the cliff.
- Strive to be the last man standing with cash and credit intact.
- Cash is king.
This article is written by or on behalf of an outsourced columnist and does not necessarily reflect the views of Castanet.