Vital truths about managing your costs

Four truths apply to every business situation: 1. It is essential to be a lower cost supplier. 2. To stay competitive, inflation-adjusted costs of producing and supplying products and services must trend downward. 3. The true cost and profit pictures for each product/market segment must always be known, and traditional accounting practices must not obscure them. 4. A business must concentrate as much on cash flow and balance-sheet strengths as it does on profits. In order to ascertain exactly what your costs are, you must carefully isolate and assign various costs to specific products, accounts, or markets. Managers often do this badly, working on the basis of "average" costs. This ignores important differences among products and the fact that different products, different markets, and different customers incur different overhead costs. Most manufacturing companies' most important expense categories are R&D, sales, and general and administrative costs, but surprisingly, they generally don't get the attention they should. Neither do two crucial ratios-gross margin and the percent of assets employed per dollar of sales. Gross margins should usually not be less than 40%, and for most manufacturing companies, assets should not be over 60% of annual sales. Wrong deviation from these ratios will undermine profit targets. Once your costs are known and clearly assigned to product lines, markets, and key customers, they should be widely shared in the organization so that everyone will feel committed to cost management and know when deviations occur.