Reducing costs associated with operations will not only increase the profitability but will also help in increasing liquidity of cash for any business. However, reducing operational costs without sacrificing quality is a challenge that is commonly faced by every business. Achieving this goal majorly revolves around effective and efficient use of technology, operations management, and regular employee engagement for training and feedback. From the early days of industrial revolution there have been many strategies like total quality management, continuous improvement etc. which were used by statisticians and quality professionals to optimize the operational costs while maintaining exceptional quality. We will discuss how we can leverage technology, operations management and strategic management to achieve this goal for any organization.

1. Leverage Technology

• Automation

Effective allocation of resources is one of the major challenges for any organisation which deals with high volume of customers or queries regardless of the domain in which the organisation is working. Automation tools can substantially reduce human error, can streamline processes having repetitive tasks and free up employees for training and high value work. Businesses which generally face high volume of customer queries can benefit substantially from robotic process automation in handling administrative tasks. Chat bots can assist customers with their queries can reduce dependence on manpower substantially.

• Cloud Computing

Migrating data to cloud can not only reduces costs linked with maintaining physical servers but also provides scalability to the business in terms of the data management. Cloud services provide excellent customization features where businesses can pay only for the services which they are using. Hence migrating to cloud from physical servers not only provides excellent customization and scalability features but also provides a robust and cost-effective IT infrastructure.

• Data Analytics

Using data analytics not only helps describing the current situation of the business in financial and operational aspects it also helps in identifying areas of opportunity where cost reduction can be done. By effective application of predictive analytics costs can be optimized by accurately forecasting demand, optimizing inventory and improving supply chain.

 

2. Optimize Supply Chain Management

• Supplier Relationships

Periodic review of supplier expenses will not only help to find areas where cost reduction can be done it also gives the indication it might be the time to look for new suppliers. If current suppliers are not providing services as per the supplier quality requirements it becomes important to find out new suppliers who might give better terms for services without compromising the quality.

• Inventory Management

Costs related with holding the inventory and waste become substantially large if inventory management is poor. Implementing inventory systems like just-in-time (JIT) can effectively reduce the inventory holding costs and can also minimize waste.  Effectively managing economic order quantity and tracking inventory real time with the help of latest technologies will ensure accurate stock as per predicted demand and will eliminate risk of overstocking and stock outs.

3. Enhance Workforce Efficiency

• Training and Development

Trained employees can not only save time by working more efficiently and productively they can also contribute to problem solving and hence can prove an incredible asset for cost saving. Training and development programmes improve cost effectiveness by enhancing skills and hence increasing productivity and efficiency of an any business.

• Flexible Working Arrangements

Managing facilities for carrying day to day operations costs on a daily basis and there are many costs associated with facility management which can be minimized. New working models like hybrid working environment and work from home reduces office space requirements and costs associated with managing day to day operations. Statistical studies have shown that such operating models have also increased employee satisfaction, which can be a motivating factor for employees to perform well.

• Performance Management

Operational efficiency of employees is what makes a company efficient at the ground level of their operations. Performance management system in simple words is a system which makes sure that employees are performing and are striving for success. Rewarding who are performing well and encouraging who are facing hard time with their performance will create a culture of improvement and appreciation in the organisation and motivated team is capable of creating wonders in any domain.

4. Energy Efficiency

• Sustainable Practices

Hybrid operating models and work from home models will definitely reduce day to day operating cost for a business whose operations can be carried out remotely. But for organisations which require manpower to work onsite investing in energy efficient equipment for the facility can save a lot of money in a long run. Implementing sustainable practices will also help in reducing the energy consumption to carry out daily operations for the company. Switching to LED lighting, replacing the old HVAC systems with new energy efficient systems, and implementing practices to use water saving fixtures can save a substantial amount of money by lowering utility bills each month.

• Renewable Energy

Considering renewable energy sources can be tough decision for the management as the initial costs for the setup is high. However, if the location of the facility provides enough sunlight throughout the year than this one move can reduce expenses and save a lot of money in a long run.

5. Outsource Non-Core Functions

Every business has many non-core functions like payroll. IT support, and customer services now maintaining the infrastructure for these functions and keeping employees onboard for these functions will cause significant expenses. However, outsourcing these non-core functions will not only lead to substantial cost reduction but also increase output as only core business activities will be handled by the employees and non-core activities would be handled by expert service providers.

6. Continuous Improvement

Every business is associated processes which have their designed outputs. By ensuring that each process is accomplished with nearly zero defects can reduce the costs associated with defects and errors. With the application of six sigma methodology variations can be controlled to 3.4 defects per million opportunities which can correspond to 99.996% accuracy in processes. Reducing waste is another aspect where organisations waste a lot of money waste can be eliminated by using lean principles. Techniques like Kaizen which ensures improvement at all levels can be adopted at every level of operation to improve the process and eliminate waste.

7. Financial Management

• Budgeting and Forecasting

Effective budgeting process not only tracks expenses for an organisation but also helps in identifying areas where the business actually went over the allowable expense limit. Forecasting is other tool that any business can use to predict accurately what changes they might face in future financially. Effective implementation and review of these two processes will assure cost reduction and adaptability to any change in the future.

• Cost Control Measures

Utilizing cost control measures like expense approval workflow which will require justification of significant expenses will help in tracking how much should be spent on any given process for the organisation. Implementing these workflows will ensure that all spending is necessary and is required to achieve business goals.

 

Conclusion

We can conclude easily that reducing operational costs require strategic, innovative and committed actions at multiple fronts such as technology, operations management, supply chain management, workforce management, finance management, and strategic business management. Most important factor that contributes towards the success of such optimization projects is actually the commitment of the senior management towards the change. Many organisations in the United Kingdom have run optimization projects internally and have millions of pounds in recent years. It is just the effective change management and encouragement for such internal which will help in making amazing financial savings which can be used for rapid expansion as well.

Every business has one goal which is to earn as much profit as possible by providing solution either by a product or a service. The ability to run operations and manage sales is not enough to ensure the sustainability and growth of business. Ensuring profitability requires efficient decision- making and maintaining financial health along with operations and sales. Monitoring financial metrics and taking decisions in accordance with the current situation indicated by the insights from the metrics is crucial to manage financial aspect of any business. We would be elaborating important financial metrics which every business owner must understand and apply to ensure growth and profitability.

Revenue

Definition: In simple words revenue is the money generated by your business by sales of either goods or services.

Why It Matters: A company whose products or services are performing well in the market would generate more revenue that its peers. Hence, revenue can be used in analysing a company’s position with respect to its competitors.

Calculation: Revenue=Number of Units Sold × Unit Price

Gross Profit Margin

Definition: It is obtained by taking out cost of goods sold from the revenue and dividing the difference by the revenue. The ratio is expressed in percentage which gives the efficiency of a company to convert its resources into goods and services.

Why It Matters:  As defined above it indicates the percentage of money that a business or a company retains from its revenue. Higher the percentage greater is the amount that a company actually retains from each dollar of revenue on a unitary comparison basis. Hence a higher gross profit is desired from operations of a business.

Calculation: Gross profit margin = (Revenue – Cost of goods sold) ÷ revenue × 100

Net Profit Margin

Definition: Net profit margin can be understood as the revenue left in percentage of total revenue after taking out all expenses, including cost of selling goods, taxes, interest and operating expenses. It is just ratio of net profit to revenue expressed as a percentage.

Why It Matters: As given in the definition we can observe that it is simply the ratio of net profit to revenue expressed in percentage. It means how much net profit a company is able to extract from the revenue after taking care of expenses, costs, and taxes. Hence this metric indicates the efficiency of a company to manage its expenses from the revenue earned.

Calculation: Net Profit Margin= (Net Profit/ Revenue) × 100

Operating Margin

Definition: Operating margin in simple words is the ratio of operating income which is revenue after taking out the operating expenses like wages and raw material but before paying taxes and interests. It indicates how much profit a company makes after covering the operating costs.

Why It Matters: If operating margin is high, it means that company is efficiently managing operations and controlling operating costs effectively.

Calculation: Operating Margin= (Operating Income/ Revenue) × 10 Cash Flow

Definition: Cash flow represents the flow of cash or cash equivalents in and out of the company through operations, investments and financing activities. A company can only generate value for its stakeholders if the company is able to create positive cash flow and maximize the free cash flow which is noting but the free cash left after accounting for the expenses and capital expenditures.

Why It Matters: Positive cash flows mean the business is generating cash from operations and investments which indicates that company can take care of its financial obligations and can also have a cash buffer to tackle tough times.

Calculation: Cash Flow= Cash Inflows−Cash Outflows

 

Current Ratio

Definition: Current ratio is a measure of liquidity of a company it is simply the ratio of current assets like cash, account receivables, inventory and other current assets to current liabilities. In simple words current ratio is a comparison between current assets and liabilities which informs analysts and investors about the capability of a company to take care of its current liabilities.

Why It Matters: Current ratio is basically a snapshot of current liquidity of a company. A value less than one indicates trouble in maintaining current obligations and a value greater than one indicates a better short-term solvency for a company.

Calculation: Current Ratio= Current Assets/Current Liabilities

 

Quick Ratio

Definition: Quick ratio is the ratio of a company’s assets which can be quickly converted into cash and is used to analyse a company’s liquidity and financial health. It indicates how quickly can a company use its near cash assets to take care of its financial liabilities. The advantage of quick ratio is its sensitivity in terms of analysing the short- term solvency. 

Why It Matters: A higher value indicates greater liquidity and stable financial health. A lower value indicates less liquidity and hints that the company may struggle while repaying debts.

 

Calculation: Quick Ratio= (Current Assets−Inventory)/ Current Liabilities

 

Debt-to-Equity Ratio

Definition: Debt to equity is ratio is calculated to compare the weights of debt and equity in a company. It is mathematically just the ratio of total debt to shareholder’s equity in a company. This ratio is also known as gearing ratio as it gives the idea about leveraging debt to run operations. If this ratio is greater than one it indicates that the company is using debt to run its operations which is a good thing if company is able to generate a positive cash flow.

Why It Matters: If the value of debt-to-equity ratio is higher it means that the company is running its operations majorly on debt which indicates greater risk for investors. However, higher ratio for a company bringing in positive cash flow is a good thing as it is efficiently using debt but higher ratio for a company with negative cash flow is a big red sign for the investors and shareholders. A company with a lower value of debt-to-equity ratio indicates less obligations and financial stability.

Calculation: Debt-to-Equity Ratio= Total Liabilities/Shareholder Equity

 

Return on Equity (ROE)

Definition: Return on equity in layman’s language gives profit made per dollar on shareholder’s equity. For a fiscal year return on equity is calculated by dividing net income made annually by total shareholder’s equity. The ratio is then expressed in percentage which represents the profit made on the equity capital and is crucial in estimating the capability of the company to turn equity investments made by the shareholders into profit. It is also an indicator of decision-making capability of the management as we are measuring how much a company efficiently gives back to its shareholders as profit.

Why It Matters: A stable and increasing trend in the return on equity value with time indicates how wisely and efficiently the company is utilizing the shareholder’s money and producing stable and sustainable profits for them and hence is creating value for their invested money. A lower and declining value indicates poor decision-making ability of the management to generate value for shareholder’s investment. A declining return on equity value also indicates that the company is losing competitive edge in the market as it is not able to provide the profits for shareholders.

Calculation: ROE= (Net Income/Shareholder Equity) ×100

 

Conclusion

A thorough understanding of these financial metrics is essential for business owners in United Kingdom. Business owners who have a complete understanding of financial metrics identify issues early and are able to take actions to rectify these issues. When these metrics are monitored and controlled by using various process improvement concepts like pareto analysis and PDCA cycle strategic excellence is achieved in business operations and financial stability is ensured for the business.  Acquiring knowledge of these metrics empowers business owners to take charge of financial and strategic aspect of business.

Financial ratios can be viewed as indicators of various financial aspects of an organisation. Liquidity ratio can be related to the short-term liability handling capability of a company and profitability ratios can be understood as an index to measure profit making capability at various levels of inspection. Liquidity and Profitability are important aspects which must be measured for a business, but there are other financial attributes which are important to check solvency, efficiency, and market value of a company to efficiently manage a company and to make investment related decisions in the company.

 

 Solvency Ratios

As the name suggests solvency ratios are used to estimate solvency of a company. The word solvency in financial context means the capability of a company to maintain long-term operations and meet long-term obligations towards creditors and shareholders. Mathematically solvency ratios can be understood as the ratios used to compare forces of money generation and money consumption which are commonly known as profitability and financial obligations. The general relation for solvency ratio can be summarised as:

Solvency Ratio = (Net Income + Depreciation) / All Liabilities (Short-term + Long-term Liabilities)

 

a. Debt to Equity Ratio:

Formula: Debt to equity ratio = Total Liabilities / Shareholder’s Equity

Significance: Debt to equity ratio in simple words is a measure of financial leverage of a company which actually quantifies the degree to which a company is using debt to fund operations. The mathematical value can be obtained by dividing total debt by total shareholder’s equity. A lower value of this ratio is preferred as a lower value indicates that company is using debt to a lesser degree to run its operations.

 

b. Interest Coverage Ratio:

Formula: Interest coverage ratio = Earnings Before Interest and Taxes (EBIT) / Interest Expenses

Significance: This ratio in layman terms can be described as a company’s capability to cover interest on debts by profits from day-to-day operations. Mathematically it is obtained by dividing the earnings before taxes by interest expenses. A higher value will indicate sufficient operating profits to pay for interests on debt hence greater sustainability.

 

 Efficiency Ratios

Efficiency ratios in simple words are ratios which indicates the efficiency of a company to generate profits using resources, capital, and assets. These ratios are basically for comparing the expenses with the profit generated for business operations.

a. Inventory Turnover Ratio:

Formula: Inventory turnover ratio = Cost of Goods Sold / Average Inventory

Significance:  As the name suggests this ratio computes the number of times a company sells out the stock it has in a particular time frame. The higher this ratio is greater number of times it sells out its stock hence greater is the profit as average inventory for that time is less.

 

b. Accounts Receivable Turnover Ratio:

Formula: Accounts receivable ratio = Net Credit Sales / Average Accounts Receivable

Significance: This ratio in simple words is actually the number of times an organisation collects its accounts receivables over a particular period of time. This ratio in simple words calculates the efficiency of revenue collection for a given time period. It is calculated by dividing net credit sales by average accounts receivables where net credit sales is sales on credit minus sales returns and sales allowances and average accounts receivables is the average of starting and ending accounts receivables balance.

 

c. Asset Turnover Ratio:

Formula: Asset turnover ratio = Revenue / Average Total Assets

Significance:  In simple words it is the measure of how sales in pound every pound invested in assets is generating. It is calculated mathematically by dividing net sales which is sales allowance, sales returned, and sales discounts subtracted from total sales by average total assets.

 

d. Accounts Payable Turnover Ratio

Formula: Accounts Payable Turnover ratio = Net Credit Purchase/ Average Accounts Payable

Significance: Accounts payable turnover ratio is a number which is actually average number of times a company pays its creditors in a particular period. This ratio is also an indicator of short-term liquidity as higher value of the accounts payable ratio means that the company is able to hold the cash for longer time. This is also correlated to the working capital funding gap inversely.

 

Market Value Ratios

Market value is simply the worth of a company or an asset in the financial market. Market value ratios are ratios which help in getting information about performance of a company in the market and the perceived value by the investors for the company.

a. Price to Earnings (P/E) Ratio:

Formula: Price to Earnings ratio = Market Price per Share / Earnings per Share (EPS)

Significance: This ratio is simply market price share of a company divided by the earnings per share which indicates the amount of investment an investor would be willing to invest per round of earning. A higher price to earning ratio will indicate higher odds for future as investors would be willing to invest more in the company.

 

b. Dividend Yield:

Formula:  Dividend yield = Annual Dividends per Share / Market Price per Share

Significance: Dividend yield in layman terms gives the return on investment for shareholders. It is ratio of annual dividends per share to marker price per share which is an indicator of the company’s ability to efficiently make profit for the shareholders. A high value of dividend yield can attract investors who are income focused.

 

Conclusion

Profitability, sustainability and efficiency of any business depends the efficient decision making and financial planning in every aspect of business. Analysis of financial ratios helps in getting insights about various aspects of a business-like liquidity, profitability, solvency, market performance, and efficiency. Periodic review of these ratios helps business owners in process improvement strategies, identifying weakness and strengths, and adjusting plan of actions in accordance with the future goals of the business. Business owners in the United Kingdom can learn the fundamentals of these ratios and can implement these concepts to monitor, review and adjust their strategies to ensure growth and profitability of their business.