What can you do when costs get out of control?

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Johannesburg (Photo credit: austinevan)

The Free State’s Young Farmer of the Year for 2014 shared his saddest day in his farming career:

He had to sell his 400-strong dairy herd five years ago because his declining profit margin made it impossible for him to continue.

The local agricultural publication Farmers Weekly reports that the farmer has now gone in for diversification to spread his risk through beef cattle and sheep, irrigated wheat, maize, sunflower and lucerne.

The thing in business is to remove emotion from your decision-making and keep detailed records so that you know exactly what your profit margin is. It doesn’t matter if you are running a huge farm, a kitchen-table start-up or a store on main street or in a shopping centre. Basic financial principles apply to whatever business you are operating.

I was talking to the manager of a store that was located in a Bryanston, Johannesburg, shopping centre but when the rent went up from R50,000 to R55,000 the owner who was struggling to make a profit from the store had to close down. He’s moved on to Boksburg, Johannesburg, where he is now running his own pizza joint.

Another small business owner I know moved from a shopping centre in Rosebank, Johannesburg, and took his business out into a suburb where his rental is a fraction of what it was under the corporate landlord.

In this recession, several small businesses have migrated to communities where they are able to reduce their costs mainly through lower shopping rentals. This migration has had a positive impact on one local community I can think of where at least five restaurants are now clustered together at two street corners, facing each other, where customers can dine with personalised service and attention and even eat alfresco when the weather is good. Not only is the mushrooming of the small restaurants beneficial to local customers because the restaurants are closer to home but the prices are slightly lower because they don’t have to pay astronomically high rentals.

Small businesses need to analyse their sales and keep close customer and sales records so that they are able to adapt their marketing strategy and concentrate on more profitable customers and products. They would typically look at things such as which products customers are buying, which they sell the most of, how their sales mix is changing over time, and watch their selling prices. This is the right thing to do. The reason is that sales determine whether you have a business or not. But profits are dependent on your costs including cost of sales, overheads and variable costs.

To keep costs down, a start-up small business will typically try to secure the lowest cost rental possible. This would not apply in an online business but then they would also make sure that their online retail space is acquired at the lowest possible cost. In this case it would mean building a retail website as cheaply as possible.

Some small businesses would also rather acquire second-hand equipment such as vehicles and machinery than buy new. Forfeiting the so-called “guarantees and warranties” from new purchases they would need to rely on their own source of funding should they experience mechanical breakdowns. Cost of sales is very much dependent on sharp purchasing practices, negotiating the best deals from suppliers. The lower your fixed costs the more room you have to move. A close understanding of your breakeven point for your business and your breakeven margin is crucial because once you drop to this level you are in the danger zone. Understanding your marginal cost of production makes you better equipped to know when you start losing money.

The operating environment for small businesses is changing with costs of energy, labour and retail space increasing. New ways of working, new methods and approaches, new strategies are required to to increase profit margin. You need options. The award-winning farmer sadly had to sell off his dairy herd but came up with a plan to diversify and make his farm production more profitable.

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