A thorough understanding of your company’s revenue and expenses is essential to its smooth operation and future expansion. After all, you run the danger of making rash decisions if you can’t see the whole picture of your cash flow. And that’s precisely why you’ll find “cost of sales” in corporate financials. Now, in this pro guide to reducing the cost of sales, we explain everything there is to know about doing so. We start by explaining what the notion actually means.
What ”cost of sales” actually is?
Simply put, ‘‘cost of sales” refers to the cost of creating a certain product or a service, and is used to calculate what we call ”gross profit”. Gross profit, as such, is calculated once we subtract the cost of sales from the revenue. Naturally, if specific expenses aren’t necessary to be made during the manufacturing process of a product/service, cutting on them will increase the gross profit. Of course, the higher your sales, the less of an impact on the gross profit COS has. That being said, for your business to be in the black, try to increase sales on your websites, for instance, by implementing particular tactics.
What does the cost of sales include?
Costs associated with the creation of a product or a service are many and differ from company to company. In addition, they are highly dependent on the manufacturing process, storing, and the way you deliver the products/service. With that being said, here’s what’s typically included in the cost of sales:
- Cost of labor
- Unprocessed materials
- Some but not all costs of running a facility
- Packaging and storage expenses
- Software licenses
On another hand, these expenses aren’t calculated into the cost of sales:
- Administrative and marketing expenses
- Costs of distribution
- Rent, utilities, and office supplies
- Equipment necessary for the production process
All in all, you might expect a broad variety of expenses to be included in your cost of sales, depending on the nature of your business, its size, and the goods or services you sell. For example, the cost of sales of a tiny consulting business will be completely different than that of a large coffee shop chain.
Proven ways of reducing the cost of sales
The cost of sales is one of the most poorly grasped metrics in the vast realm of sales and marketing. The sad reality is that many employers see it as nothing but labor cost and, therefore, opt to pay lower commissions to their staff in an effort to cut down on it.
That, however, is an extremely simplistic viewpoint. The only way sales expenses really matter is if they cut into profits. In fact, as a business owner, your objective should be to increase the effectiveness of your sales costs, rather than only make them smaller.
To make matters even more complicated, a portion of businesses’ cost of sales is buried within the finances of a variety of different groups; which is particularly true for companies that are in the marketing and IT sphere. All this only means that, in order to effectively reduce the cost of sales, a much broader approach has to be taken.
#1 Focus on profit rather than gross revenue
Gross revenue is still widely used to measure the performance of sales by a variety of businesses today. However, if you’re only concerned with revenue, you may find yourself trying to make up for a loss in profit per transaction by increasing sales overall.
In the past, back-office systems couldn’t disclose the success of each sale, making profit-based compensation impossible. However, in the modern era, most companies have a strong idea of their cost of goods, allowing them to provide salespeople with accurate projections of the profit their efforts are bringing in.
Since making a profit is the ultimate goal of all businesses, calculating sales in terms of profit margin makes perfect sense. The major advantage of this strategy is that the instances of offering discounts in order to close the deal are brought to a minimum. And as discounts are none other than sales expenses, this certainly helps in reducing the cost of sales.
#2 Form a strategic partnership with particular customers
There are instances when acquiring and retaining a customer is more valuable than the money they bring in. For example, a small software company could claim a renowned name as a client and use that fact to bolster its reputation. In this particular case, keeping this client satisfied in the long run is more important than worrying about the profit. After all, that same client could easily bring more clients in, thus compensating for the initial loss of profit. The same logic may apply to a marketing services agency that loses money on a test project in the hopes of landing a larger contract.
By now you should have realized that profit isn’t everything. That being said, while you would generally pay salespeople based on their contribution, you should also be willing to adapt their pay based on some other indicators. Those being customer retention and/or satisfaction, for instance.
#3 Measure your marketing efforts through the conversion rate
To some companies, marketing is more of a strategic endeavor than a tactical one. This is particularly bad for your cost of sales. Why? Well, because it makes the marketing department focus more on process than on output.
To fix this, it’s necessary to stop evaluating the marketing department’s performance based on how many focus groups they have or how many leaflets they print. Instead, businesses should start evaluating them based on the quality of leads they generate – with quality being determined by how quickly those leads convert into paying customers.
Does your business struggle with relatively high bounce rates and a low percentage of new leads? If so, it might be time for you to improve your website. After all, you would be surprised by what a difference adding an exit popup software, for example, can make.
#4 Involve the research and development department only when necessary
Research and development personnel can and should be involved in sales efforts. In fact, in the case of more complex products and services, they often are involved. However, the sales cost might skyrocket if R&D staff is tasked with closing deals. Think about it: every day an engineer spends helping salespeople is a day an engineer isn’t working on their current project. Furthermore, when R&D resources are used in sales circumstances, it can lead to salespeople trying to market items or products that don’t exist, thereby pushing R&D to conduct work that is only useful to specific clients.
That being said, instead of forcing the research and development department to do what isn’t essentially within their job description, how about you helped your sales staff increase sales by making use of a callback system? By utilizing one, they won’t have to rely on R&D as much. In addition, taking advantage of such a system is bound to help in reducing the cost of sales.
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