Brian Tracy Building your business pt.6- determine the cost
Your goal is to build a successful business and every. Year they study thousands, of businesses that go broke and analyze, what are the reasons and, one of the major reasons, is poor cost. Control is, the company might be doing great in terms of sales and revenues, and activities, and so on but, their costs, get out of control and the company collapses. They run out of cash, there's. A rule so, that says that life is the study of attention. And the, more attention. You pay to your costs, the better you get at, knowing, your cost and especially at, reducing, them so. The rule is you must know the exact, cost of every ingredient, that goes into the production of your products, or services, and very. Few, people know the exact costs, business. Success requires, that you tightly monitor. Or control. All your costs at, all times, some. Years ago I worked for a man who started with nothing and built a fortune of eight hundred million dollars and, I was amazed that even, at the time when he had his own private jet he had beautiful homes, and luxury resorts, he, had hundreds, of office, buildings banks, shopping, centers he. Still was meticulous. About, the cost of every, single, ingredient and, that. Philosophy. Expressed, itself out through the entire company, and that, company was profitable year. After. Year and you must do the same as well successful. Entrepreneurs, are careful. With their money they. Control, their costs at all times they, practice, frugality. Frugality. Frugality. They're, always, tight fisted and interesting. Enough if you look at some of the biggest and most successful. Multi-billion. Dollar worldwide, companies. They're, also very. Careful. With their costs, they, never take anything for granted and, they are never excessive. If they can possibly avoid it well. It's essential, that you know the exact cost of every product and service that you sell because. You earn a profit, by, selling a product at a price that is greater, than the total cost of producing. It here's. An interesting discovery, because. Of poor cost control, many, companies, actually lose. On many of the products that they sell they're, selling, a lot of them but because of cost of promotion, Commission's returns. Breakage. Shrinkage and all those other things they're, actually losing, money so they spend, more of their resources, selling, more of the products and they, keep losing more and more money. Ongoing. Cost analysis. Is a key responsibility. Well. In. In, the university, they teach you what is called micro, economic, theory and I took these courses some, years ago and micro, economic, theory explains, the relationships. Between cost, and price and I want to just give you three laws that you can think about number. One is called the law of increasing returns. What. This says is that the more that you produce the. Lower the cost will be per, item that you produce now. Here's an important thing when. You start to produce a new product or service or you start a new business everything. Is very expensive at, the beginning, because, you're going through a learning, process you, make every mistake you, make every, cost. Overrun. It. Costs a lot but as you get better and better and you smooth, out the system you, will find that you can produce the same quality, and quantity of products, and services at a much lower cost and, especially, by the way you see this in manufacturing, but, it takes a lot of money to set up the factory to set up the equipment to train the people the, first few products cost a lot but the better and better they get at it the more smoothly, they produce it the lower the price becomes, and this, is often the key to, dominating. The market is, to be able to become so efficient, that, your costs. Are so low and you pass on those lower costs, to your customers, and of, course outsell, your competition, that's. The law of increasing returns, the law of decreasing, returns is the flip side with. Some products, you will actually earn less profit, with each item in, other words because it costs you so much to upgrade, your facilities, to produce more products, you'll, actually lower, your profit, level by trying to sell too many a perfect. Example of that by the way is Harley Davidson company Harley. Davidson company is always. Selling, at the outside. Limit of their production, and they're, encouraged why don't you build new factories because, if you build new factories, and there was a cutback.
Or A slowdown, in sales, we. Would suddenly have, the law of decreasing, returns we'd, have all these factories, and people, on staff and we'd. Be selling fewer so, what they do is, they, produce, at the level where they can make the maximum, profit which, brings us to the third law the, third law is called the law of marginal, return and the, goal in the law of marginal, return is, to sell exactly, the right quantity, of products to earn the, highest possible, profit and you'll. Find that every company has a point, where at this level of sales with, this level of cost they, make the highest profit per unit and that is the optimum. Point it's the point that every company aims at and, then you have to aim at as well, well. There. Are several different kinds of costs, that you must be aware of as a business person the. First costs are what are called fixed, costs now, fixed, costs these, are costs that you incur whether, you make any sales at all to. Do a fixed cost analysis. You, would say if we made zero, sales in the following month how, much would it cost us to keep our doors open and then. You realize immediately that. A fixed cost is rent a fixed, cost is permanent, staff labor. Utilities. Taxes. Whose, salaries, their, fixed costs are things that you have to pay whether you make no sales at all that, becomes your base your foundation, and one. Of the things that you try to do in business you try to keep lowering your fixed costs which, brings us to the next type of cost called variable, costs now a variable, costs are cost that you incur each. Time you make a sale for, example there's. The cost of the goods, sold the product or service that you, buy or build to sell there's the cost of sales sales, commissions, advertising. Delivery shipping these, are costs that are only occurred, if you make a sale so, if you can imagine stacking. First, you have your fixed, cost then you have your variable cost that stack on top of that the. Third type of costs, are your semi, variable, costs, these, are costs that are partially, fixed and partially, variable, that, for instance a labor cost. Parsley fixed but you can cut back on it by laying people off or by hiring temps these, costs, go up and down and you have a little bit of control over them and they, vary depending upon, your, level of business activity, and so. Then you put your semi variable, cost like the third level onto, your total fixed variable. And semi variable. Another. Type of cost that people have and is very important, it's called a sunk, cost, now. A sunk cost is, money that is gone forever you. Can never get it back for. Instance it could be an advertising, campaign you, engaged in last year it, could be a piece. Of equipment, that you bought that is obsolete it, could be a computer, that is broken, that no longer works it could be furniture, that's, over, in your storage in, other words a fixed cost is money you can never recover the. Reason I mentioned this is that many companies and, many business people make, the mistake of trying, to recover fixed. Costs, money, that's lost forever, by investing, more money we, call this pouring, money down a rat hole or. Sending. Good. Money after bad, when. You have made a business mistake, and you have lost the money recognize. That it's irretrievable. And don't, spend more money trying. To make back something that you can't get back, the. Final cost you have to be concerned with is called an opportunity, cost now, an opportunity cost is important, this is money that you could earn if you invested. The, same amount in another product or service, or activity, for. Example let us say that to. Engage in this activity to, produce this product or service bringing, it to the market will, cost a hundred thousand, dollars before. You make that decision ask, what, else could. I do with, the hundred thousand dollars and could I earn a higher return, let. Me give you an example some. Friends of mine had built up over the years in their family a very, successful, lumberyard. And they, built it almost in the center of town and over the course of 20 30 40 years the, city had grown to a hundred hundred and fifty thousand, population and, this, land was, some of the best land. In the city. They continue, to operate their business they continue to make two, or three hundred thousand dollars a year profit on their business which, was distributed to their family members one. Day, hot. Summer the, lumberyard caught on fire and it burned down completely, well. It, was completely, insured so, the insurance company presented them with an insurance check, something like twenty million dollars. Well. The, question was how, quickly do we rebuild or do we rebuild outside, of town do we sell the land and then they realized wait a minute they, could invest that twenty million dollars, very, carefully, and intelligently, and earn, twice as much each year or more, than.
They Were earning running, the entire lumber, company with the whole family, working in the company so. What they did is they just simply reinvested. The insurance, proceeds and the whole family, retired because. Of the opportunity. Cost, so, keep asking whenever you have to make an investment is, there some other opportunity. That you could invest the same money in that, would give you a higher or safer, or more predictable, level of return, opportunity. Costs are absolutely, critical. Well. In, looking at your business there are several costs, that you must include the, first cost of course is the costs of the products and services that you buy from others for resale, not. Only the products or services but all the supplies the cost of the materials, that you purchase the office materials, the computers. The telephones. The accounting. Equipment and so on you, have to include the cost of all labor and there's, two types of labor there's direct, and indirect, for. Example we have an internet business in, our internet business we have half, of the people who work there are direct, they're on our internal payroll, the, other half of people the people who work in the internet business are indirect, they're outside contractors. But their labor is essential, to the business so, when we calculate the cost of the internet business as a separate, business within, the business we, calculate, all labor, inside, and outside, you. Also have to include the cost of sales and marketing and. Commissions. And advertising. Per, product or service, that you sell now. This is important, one, of the most important, costs you have in business is what is called your, position cost, it's your cost of acquiring, a sale, sometimes. It's customer, acquisition, cost your, cost of acquiring a customer, who, then may make, several sales but, you have to think how, much do you pay to, get a sale in the first place. When. I began my professional speaking. Career many years ago I I. Say I learned to sell again when I began speaking I sold, my house I sold my car I sold, my furniture I sold, every bit of savings, and and investments. That I ever had in order to start my business what. I found is because of my inexperience is that, in the first year of speaking, I paid. 110. Dollars per, person for, people to come to my seminars, and listen to me in others I didn't, get anything back I paid, out of pocket it, cost me a hundred and ten dollars to acquire a person. Who would listen of, course over the years that change but, in your business you have to ask yourself how much are you willing to pay for a customer, in terms, of advertising sales. Commissions, marketing. Costs, and so on how, much are you willing to pay per product, or service that you sell and, then, you ask yourself how much, is it costing today. To, acquire a customer and, could, you lower that cost of, customer acquisition could. You lower that cost of, acquisition of, each sale it's a critical, cost you, have to calculate. Another. Cost is the cost of packaging, the cost of shipping the cost of distribution the. Cost of the people who put it together the cost of a mail, and postage, at UPS and FedEx and everything else what, does it cost to get your product, or service, to the customer do. You know that a single letter, that, you write to a customer, cost anywhere from 25, to 75, dollars, by, the time you have taken your time to, write the letter by the time the secretary, has typed it by the time it's been put on stationery, put into an envelope and put, into the, truck. Through the franking machine and then taken to the post office all, labor costs, it's 25, to 75 dollars, per letter it's, absolutely, phenomenal when.
You Start to look and breakdown each little cost. You, also if you're selling that product especially you, also have to include the costs of what are called shrinkage. Waste. Loss. And also. Theft, and breakage. It's. Interesting, many companies restaurants especially but many department, stores retail, businesses will, actually make profits, on the front end and go bankrupt because of the amount of theft that takes place on the back end, so. What you have to do to, say what if what are the what are the lost cost how, many of our product or service disappears. We. Used to do seminars with a large organization. And we, would send them five, thousand units and they, would come back to us and they would give us an accounting, less, shrinkage. Of three hundred units we, call them up when we say what's shrinkage well this, is what, we include, into our costs, it's just products, that somehow, disappeared. What, we found out later that they were giving, the products away they were actually selling them and not accounting for them so we eliminated. The shrinkage we said zero shrinkage, I said no no no we we include shrinkage, in all of our businesses is it you don't include shrinkage, with our stuff so, ask yourself how much is being wasted how, much meat is being lost how much is being thrown away but. Especially theft, and breakage sometimes. A product that is broken cost you an enormous amount of money and wipes out the profit from, five other products, that you sell but, that is a cost of business as well and it's usually expressed. As a percentage, of total sales, now. Another. Cost is interest cost if you, are borrowing money on your, line. Of credit you have to pay interest every month and what you do is you have to allocate, your interest cost against. The, products, and services, that you sell so. Let's say you pay a thousand, dollars a month in interest and you sell a thousand, units of your product what. You do is you allocate $1 per unit in interest cost let's. Say 80%, of your sales come from one product area, and 20%, comes, from the other then, you allocate 80%. Or $800. To that area as an interest cost cost. Of doing business okay, it's very important. That you be both accurate, and honest. Another. Cost that you have to consider is bad debts now. Bad debts run differently. In different industries, sometimes. Their 3%, sometime or 5 or 10% if, you, have. High markup products, then, you can absorb, bad, debts more. Than if you have low markup products but, bad debts can cost you an enormous amount of money and some, companies actually go broke because they don't get paid substantial. Amounts this, is why you have to be very very tight with regard to credit you, have to follow up when people don't pay you have to demand payment in advance cash. You have to make sure credit cards clear because, bad debts drain. Away all of your profits, you can make it on the top line and actually, lose money because, of bad debts and because of shrinkage and.
Then Finally you have to include all other costs that must be paid well. There are several companies now that do this type of cost analysis, and you know what they do is, they go into a company and they'll take a particular product, and they'll say alright let, us work out 100%, of the costs, attributable to, this product relative. To the, amount you sell it for and profit, then, they'll take every, single, product and they, will do an analysis, and they'll, find out that in your business in any business that there, will be one product, that we yields the highest profit, of any, other product after, all of the direct and indirect costs have been calculated. Then there is a number 2 product that a number 3 product and a number 4 and in every single business you, can order every product or service in order, determined. By how much they actually earn the company, whenever. They do an analysis like this the owners of the companies are shocked, and you know why it's, because sometimes the product that, they're selling that seems to be doing so well they're, actually losing money on every one and sometimes, a product they weren't paying attention to because. It's easy to sell has, high level of customer satisfaction highly. Profitable low, returns, sometimes. A product they're not paying attention to is the mainstay, of the company so. Here's the question to you what. Is the exact, profit, down to the penny that you earn for, every, single product or service that you sell and, in, order which is number one which, is number two which is number three and so on now. Another thing that you have to do in business is you have to include the costs, of your own personal. Labor there's. Two ways that you can do this the simplest way is to ask yourself if you, were working for another company how. Much would that company, pay you per, month know, what's your last job how, much are you worth in the marketplace let's, say that you were, $60,000. A year in the marketplace that, means that that your, labor costs, your company. $5,000, a month because, that's how much of your, labor you are investing, in the company each month ask. Yourself, with regard to every product or service how, many hours, do you personally, invest, in, a product or service, one. Of the things that I've done with my entrepreneurial, clients, as I've pointed out that, there are some activities in their business that are such low value, no value that. They don't warrant very, much personal, time at all and there's, some areas in their business that are have such high potential, that they warrant, almost, all of your time so. You have to keep asking is this a good use of my time is this, the most valuable, use of my time is this the best place that I can invest my, valuable. Scarce time in terms, of the, amount that it costs, to hire me for. Example if you earn $60,000. A year it, means that you earn about, $30. An hour all, right so, you have to ask yourself, every hour is what, I'm doing right now paying, $30. An hour and. What else could I be doing with my time that, has a higher potential, payoff. You. Should ask yourself what is the amount of your salary or compensation how, much do you take out of the company and allocate. That against. All your activities, ask. The for the about, the value of the labor of your family members does, your wife work with the company or your husband do your kids work in the company put. A number on their. Contribution. And attribute. It to your costs, even though you may not be paying it out directly, and. Finally ask how much could you earn if you work for another company because here's a discovery, 86%. Of entrepreneurs, because, they're not knowledgeable. In sales marketing, and cost controls. 86%. Of entrepreneurs, could actually earn more money working, for someone else than running their own business and. So. Ask yourself how much could you work or. Working, for, another company rather. Than running your own business and how, can you start to make every minute count, well. Ideally, you should reduce your fixed, costs and increase your variable, costs the lower your fixed costs the lower is your break-even point so, think, about your offices, and equipment, it's often better to lease or to rent offices, and equipment many people start in business they think about buying their own premises, know, the, smartest, and biggest companies, in the world rent, and they lease equipment because they say wait a minute I'm not in the real estate business I'm, in a different business if you're not in the real estate business it's, much better to lease and have, the flexibility, of working, out your lease and leaving rather, than to own and have no flexibility, at all sometimes.
It's Better to lease, or to rent computer, equipment, or office, equipment, or or or trucks or cars or anything, else try to keep your fixed, cost down by, avoiding buying, this stuff in the first place with. Regard to labor cost you can lower your labor cost by, hiring people to work part-time there's. A rule that says you should only hire people to work who are needed. 100%. Of the time you, should never have people on the payroll in case things pick up so. The best companies, that I know have people who are fixed, full-time. Who are working 100%. Of the time and then, they have part-timers. And tips that come in and work when the where the workload goes up a critical. Thing now that many companies are doing is outsourcing. They, hire other companies, who specialize, to, perform particular, services, for, example in terms of payroll now, there are companies like paychecks, and ADP that will come and do a hundred percent of your payroll for, you all we require is a single, check once a month and you can close your entire payroll department, these. Companies specialize. So well in payroll that they actually do a better job at. A lower, cost than it would cost you for rent utilities. People, mail, staff. Computers. And so on look. To outsource, everything that, you can that is not part of your core business one, of the great, techniques, for, running a business efficiently. And profitably. Remember. The lower your fixed costs, the higher can be your profitability, the, lower your lot in costs the more you profits you can make when, business gets going good now. There are several ways that you can calculate the efficiency with. Which you run your business and these, are tools that you can use for the rest of your career the. First is called return on investment, the, return on investment ROI, is. The amount you earn as a percentage, of the total money's, invested, in, your business now. Total monies means the amount you've invested, your friends, have invested, but also the amount of money that you've borrowed, either. Directly, or indirectly through lines of credit what's. Your percentage of return the. Second, figure. That you can use which is even better is called return on equity, the, return on equity is, the amount that you earn from, the amount of cash that, you or your friends have personally, invested, in the business this, is your out of pocket how. Much what, percentage, are you returning or earning, on the amount of you that you have invested, another. Critical, figure you can use is called return on sales now. Return on sales that sometimes called your sales margin, but it's the amount of gross profit, and net profit that, you earn from each item, that you sell for. Example if let's, say you sell an item for $1,000, and it costs you $900. To buy the item package it sell it pay for staff and everything else it, means that you earn $100. On, return. On sales from each item one, of your goals is to increase your return on sales to, earn more per item by.
Lowering The cost or by increasing the price. Or both but, this is a critical. Figure what are your returns on sales some, companies the very successful high tech companies, have 50% return on sales grocery. Stores have 3% return on sales and, it's a small change in your return on sales can dramatically, change your, results the, final number is called net profit that's, the amount that you have left, after deducting. 100%. Of all the costs listed above, what. You do is you, calculate everything, and every single month you look what is your net profit what. Is your net loss keep. Focused, you should be knowing every, single month sometimes, every week major, companies, will, know every year within seven days at the end of the year exactly, how much they've earned, why'd because. Of their sophisticated, and, complete bookie and accounting systems you. Have to determine your profitability, in each of your products and services, conduct. A complete cost, analysis, of each product, include. A percentage, of all fixed, costs, that are attributable, to. That product or service include. The exact amount of a variable, and semi variable, costs per item you. Then deduct the cost of your personal, labor at your hourly rate plus. An allowance for all losses and write-offs. Determine. Exactly, how much it cost and how much you earn from, the sale of every, product and service and finally, remember. That everything, is based on attention, you must continually, study, every, cost and look for ways to reduce them this, is a critical, part of business success many. Companies are successful, on the top-line because, they sell lots of their products and services and, they go broke because, of poor cost control, on the bottom line don't, let that happen to you. You.