We find that accountants often lead us entrepreneurs astray. They make us classify outlays of cash as investments or expenses.
But small business owners can’t afford expenses. They have to view expenses by their true nature:
They are investments.
An accounting phenomenon
When you purchase inventory or equipment, your accountant will reflect them on your Balance Sheet. You get it – these are investments.
But expenses are just costs. So they show up on your Income Statement. They get subtracted from Sales.
Why would any sane businessperson view them as investments?
Expenses are an accounting phenomenon. You have to understand how accounting works to understand why expenses are reflected as they are.
Accountants operate on the principle of conservatism. Since they can’t determine the value of an expense, they write it off in full.
But it’s still an investment.
The advantage of viewing expenses as an investment
By understanding that expenses are an investment, you can invest more wisely.
Why do you invest in inventory, equipment or any other Asset?
There’s only one good reason – to increase Sales.
Why do you have expenses?
The answer should be the same – to increase Sales.
Every single outlay of money should increase Sales. If it doesn’t ever increase Sales, you don’t need it!
Allow us to emphasize that last point – it’s really important. If an outlay never increases Sales, get rid of it. It’s money down the drain.
Let’s look at an easy example. You spend money to advertise. Assume you use some newfangled media.
If you never see an increase in Sales from this newfangled media, will you keep advertising? Of course not.
A simple way to zero in on costs to cut
Every expense works just like this advertising example. Or at least it should.
But in the busyness of day-to-day business, decisions get made and costs go up. It happens so easily – a new contract here, another contract there.
Pretty soon, your costs are bloated and your bottom line is starving. Fortunately, there’s an easy way to fix this – think like a startup!
Startup entrepreneurs know it’s easier to predict expenses than it is sales. So they focus on every single expense.
- Start by assuming you don’t need any expenses. In other words, each line item starts out with a budget of $0. (That’s why this is called zero-based budgeting.)
- Then, determine the minimum amount you need to invest in this expense to reach the level of sales you need to achieve the profit you want.
By doing this, you’ll likely wring costs out of your system. This isn’t an exercise you need to go through every year. But it’s a great way to check your costs every few years.
Demand a return on every dollar you spend and your returns will increase. You’ll make more money more dependably!
