Should I cut expenses or grow gross margin?
In this series of 19 short articles, StratPad’s founder discusses the fundamentals of starting and running a small business.
Today he discusses the difference between cutting expenses or growing profit:
Q: What is the best way to increase my bottom line?
There are two ways in my mind to increase the bottom line. One of them is cutting costs, cut your expenses. The other way is to focus on increasing your gross margin. It’s tempting to think about cutting expenses because you can do it pretty quickly and it has an immediate effect on your bottom line, but often times it’ll have negative consequences that are unforeseen. Far better to be thinking about increasing gross margin. Gross margin, of course, is simply revenues less cost of goods sold.
To increase gross margin (gross profit), you can think about increasing revenue, which is a good thing, and you can think about reducing your cost of goods sold. In other words, making your products or offering your services more efficiently and that’s a good thing and doesn’t affect your customers’ experience. Also, if you’re thinking about gross profit, it means that you’re looking at your expenses as investments. In other words, should I spend money that I’ve got in gross profit, on marketing? Yes, you should invest it in marketing as long as it has a positive return on investment (ROI). In other words, as long as it goes back and increases revenue.
I think it takes a little more time, a little more thought, to go through the gross profit examination than simply to cut expenses, but I think you end up with a stronger company by thinking about gross profit before you think about just cutting expenses.