Managing costs is fundamental to the success of any business, but it's particularly pertinent to smaller companies. “Identifying areas of unnecessary expense when you’re smaller stops those expenses becoming even bigger as you grow,” says Oliver Wimshurst, finance operations lead at Quantico Financial.
With inflation impacting the cost of doing business for many SMEs, business owners need to have a good grasp of the various costs they are incurring, and understand how to manage them in the current climate. In this article, we'll summarise the main types of business costs and offer advice on how to manage them – from reducing overheads to finding supply chain efficiencies – in order to boost your business's cash flow.
Different types of costs in business
Business costs can be divided into four broad categories:
- Fixed costs remain the same no matter how much your company produces.
- Variable costs rise or fall with production.
- Direct costs can be directly tied to production.
- Indirect costs are more general costs of running the business.
Fixed and variable costs can both be direct or indirect. We’ll explain more about each of these cost types below, but first, let’s look at how to manage business costs.
How to manage costs and boost cash flow
“Where businesses often go wrong is not sitting down and looking where they spend their money, before making changes,” says Wimshurst. By pulling together an overview of all the different costs to your business, you have a good starting point for making tweaks that could have a big impact on cash flow.
It may be that you can reduce overheads by moving to a smaller office and offering remote work to employees for part of the week. Investing in energy-efficient practices can also minimise overheads, Wimshurst adds. “Lots of small companies tend to over-recruit and over-invest in office space, but that’s an area where you can easily make adjustments.”
Businesses can also reduce costs by making supply chains more efficient. For example, tracking suppliers to spot new deals, or renegotiating with existing suppliers could help to drive lower costs or better payment terms, which will increase cash flow. With supply chains prone to price fluctuations, businesses can also protect profit margins by increasing prices or absorbing short-term price increases with cash flow reserves.
A simple, effective way to boost cash flow is to pay suppliers using an American Express® Business Gold Card, which gives you up to 54 days to clear your Card balance¹, so you can keep your money in the account for longer and get more flexibility in your cash flow. Plus, you can earn Membership Rewards® points every time you spend².
1. Types of fixed costs
Fixed costs can include things like rent, insurance and salaries, which are not tied to a company’s level of activity. Since you have to pay fixed costs regardless of how much you sell, it is important to understand and minimise fixed costs early on.
Rent
A common fixed cost for businesses is rent on office, manufacturing and storage space. This is a fixed cost because no matter how much your company produces, you still need to rent space and in most cases, office costs are fixed regardless of the company’s production.
The Baldwin Gallery is an art dealer and gallery specialising in modern art. The company does not have a gallery space, which helps reduce fixed costs, explains gallery director Adam Baldwin. “We have a warehouse that we can scale up and down as needed, and we work from a small office where we run virtual showings in place of having a high street gallery,” he says. "This means our costs are much lower.”
Insurance
Most businesses will pay for a range of insurance products, which will be paid at a fixed rate, even if production rises or falls. This might include public liability insurance, professional indemnity insurance and insurance for business premises and equipment.
2. Types of variable costs
A variable cost is any business cost that rises or falls with production. If your business increases production by 50%, for example, then your rent and insurance costs will not change. However, costs such as freelance labour, raw materials and packaging will scale with production. You can calculate variable costs using a specific formula.
Raw Materials
This is a variable cost for most businesses because the more of something you sell, the more materials you need to make new products. For example, if your company sells 10,000 more glass bottles this month compared to last month, then the cost of the raw materials to make the glass will also increase.
Freelance labour
While salaries for employees are considered a fixed expense, if you have flexible labour such as freelance, contractor or agency staff then this is likely a variable cost. You can scale up or down depending on your needs.
The Baldwin Gallery has full-time office staff but the sales teams work on commission, to allow for these costs to be minimised. “By paying commission, we know that our costs will only go up if our sales are going up,” says Baldwin.
3. Types of direct costs
Direct costs are the specific expenses incurred in getting a product or service to your customers. If your company makes cars, then the direct costs might include design, manufacturing, the cost of metal and other components, and the cost of getting the car to a dealership and paying their commission.
This isn’t quite the same as the cost of goods sold (COGS), which is a broader cost category that includes items that can’t be attributed to a specific item, such as labour, marketing and overheads.
A direct cost could be fixed or variable, depending on the business. For example, if the car company pays a fixed rent for a manufacturing site, then this is a fixed, direct cost.
Labour
This would be considered a direct cost if the cost of labour can be attributed to the product or service being sold. It may not include administrative and office staff where work isn’t related directly to a particular product or service.
Raw materials
If you buy raw materials to produce items for sale, then the cost of those materials would be considered a direct expense.
4. Types of indirect costs
Indirect costs are expenses that a business cannot directly link to production. They might include the overhead costs involved in running your business and maintaining it. Like direct costs, indirect costs may be fixed or variable.
Computers and office supplies
Computers, mobile phones, stationery and postage are all costs that are essential to the running of a business, but which can’t necessarily be directly attributed to the production of a specific item, so are indirect.
Utilities
Similarly, a business needs to keep the lights on, but that expense isn’t linked to the production of an item for sale. However, while utilities like electricity and gas may be an indirect cost for most businesses, there may be some instances where a utility could represent a direct cost: for example, a brewery's use of water would be a direct cost when the water is used as a raw material in the brewing process.
In this example, it is easy to see how managing indirect costs without affecting sales might be easier than managing direct costs: trying to cut direct water usage costs could only be done by reducing the volume of beer produced; however, other water usage costs that are indirect - such as water used for cleaning or in staff toilets - could be cut through sustainable solutions such as recycling wastewater or installing a rainwater harvesting system.
1. The maximum payment period on purchases is 54 calendar days and is obtained only if you spend on the first day of the new statement period and repay the balance in full on the due date. If you'd prefer a Card with no annual fee, rewards or other features, an alternative option is available – the Business Basic Card.
2. Membership Rewards points are earned on every full £1 spent and charged, per transaction. Terms and conditions apply.
