Managing hidden expenses

This article was written by Ed Hatton for Entrepreneur Magazine (South African edition), as the My Mentor column published in March 2016 and is posted here by their kind permission

The costs you don’t get invoices for

A potential customer walks away without buying after a bad experience with one of your employees. Your deliveryman cannot find the address so he returns with the customer’s order. Inventory at the back of the storeroom lies unused and unsaleable. A manufactured item fails a quality check and has to be remade. Clerks spend large parts of the day reconstructing lost information. These and many other failures cost your company a large amount of money, and yet the cost is almost invisible. These are the intangible costs for which you do not get invoices. They are typically a substantial part of the total costs of running a business.

Intangible costs include overstaffing, overtime, overstocking, excessive transport costs, scrapped material, excessive rent and loss of profit from lost customers and lost sales which should have been made. Few raise alarms or are subject to intensive cost cutting drives, simply because unlike direct costs nothing highlights their existence. To illustrate this point image a scene where every lost sale generated an invoice for the loss of profit. There would be a predictable response to improve competitiveness and service, but the lack of visibility of lost sales makes this response unlikely. The loss of profit is as real as the cost of wasted stationery, but seldom gets as much attention.

Tracking intangible costs

Anything affecting customer satisfaction may mean lost customers, lost sales and fewer referrals. Examples are missed delivery dates and sales lost because you have run out of stock. Do you know how many customers have stopped buying in the last year, and why they stopped? Do you do regular customer satisfaction surveys?

Second on the list is rework, and not just of manufactured items. For instance repairs that were not fixed the first time and have to be redone, or time lost finding or recreating vital information which should have been readily available. How often do you have to fix errors made because staff are unfamiliar with procedures? Doing things over is costly and demoralising.

Direct financial losses may also be hidden. For example delayed payments by customers because of queries with the paperwork will incur interest costs. You may have discovered stock items lying unused while new orders are placed for the same item, or find that the wrong items have been ordered and never returned, but these costs are buried in material purchases. Machinery or vehicle breakdowns occurring because maintenance has been neglected can be hugely expensive, but are included in service and maintenance costs. Abuse of sick leave often generates unnecessary overtime. As a result these significant costs may go unnoticed, unlike an unexpected direct cost where the payment request will usually be queried.

Measure and reduce

When you start tracking these issues you may find your staff may not regard them as being important. You will have to create a culture of lean operation, where any waste of material, time, space or opportunity is noticed and addressed. To do so you have to build an organisation where it is acceptable to make a mistake and learn from it, so that people are not motivated to hide their errors.

Start with some simple measures: Watch for obsolete stock and stock shrinkage like a hawk; these can cost millions. Find ways to track rework of all types including deliveries sent twice, re-invoicing and manufacturing and repairs needing to be redone. Analyse the causes rather than allocating blame, you may need to do more training or supply better materials or systems. Institute rigid maintenance schedules to reduce breakdowns. Find ways to track lost sales, encourage customers to report bad service.

Finally loss of institutional knowledge should be avoided. If you retrench the long serving clerk or storeman the savings may be wiped out by costs like making wrong parts, upsetting established customer routines or searching for documents which cannot be found.

© copyright Entrepreneur Media SA (Pty) Ltd. All rights reserved. No part of this article may be reproduced, stored in a retrieval system or transmitted in any form without prior permission of Entrepreneur Media (Pty) Ltd. Permission is only deemed valid if approval is in writing.