Cutting costs is tough. Particularly when you have to lay off your best people. But there’s a way to prevent it.
You may have the best plan, yet without the right culture and governance in place, all the efforts to achieve your goals and objectives might be in vain.
In this article, I’ll explain why costs get out of control and how to prevent that from happening.
Table of contents
Why is it difficult to control costs?
In a typical small business, where owners are also involved in managing day-to-day activities, we should consider this problem from both the owner-manager’s and the employee’s perspectives because the dynamics are different.
The owner’s perspective
We can’t control external factors like recession or the political environment. But we can control our behaviour.
And it all starts with you, the business leader.
I’ve noticed that owners-managers who are cost-aware personally tend to be also good at managing expenses in a business setting.
They stick to the budget. They have an emergency fund. They don’t make impulse purchases on credit.
The psychology of money is complex, and various factors influence our spending choices — emotions, values, desires, discipline, and social pressures. Spending is not bad — it fuels the economy, after all — but things get dangerous when we buy things we can’t afford.
So, the way you handle personal finances is reflected in your business decisions. It also influences the behaviour of your employees, ultimately shaping the organisation’s culture.
The employee’s perspective
Now, let’s discuss this from an employee’s standpoint.
The dynamic shifts once you bring someone on board to manage finances they don’t own. And as your business grows, you’ll eventually have to hire people to do that.
Spending someone else’s money is fun and easy, isn’t it?
This leads us to the agency problem.
It’s a conflict of interest that occurs when a manager (the agent) doesn’t always act in the business owner’s (the principal’s) best interest. While we expect managers to make decisions that maximise shareholder wealth, they might also be tempted to seek personal gains.
The issue becomes apparent in several ways:
Risk-taking: Managers might prefer aggressive strategies, chasing high-risk projects that boost their reputations and CVs. For them, the downside isn’t all that bad — they won’t lose their hard-earned money if the project fails.
Overspending: There’s a tendency to spend excessively on non-essentials. Overspending by inaction is also common: employees might not put enough effort into finding cost-effective options. For instance, they may not research better deals when arranging business travel.
Short-termism: Employees tend to prioritise quick gains over longer-term benefits when making business decisions. For example, a manager might reject a potentially good investment project because of a long payback period.
Bear in mind these tendencies when implementing the strategies we discuss next.
Cost control strategies
Now that we’ve identified why costs can get out of hand let’s explore how to overcome these challenges. I suggest the following approaches.
1. Hire the right people
First and foremost, you need people who share your financial values. The last thing you want is to give budget responsibility to someone who’s living paycheck to paycheck. During interviews, ask candidates how they approach financial dilemmas to get a sense of their lifestyle.
Further, you can organise training sessions for employees on cost awareness and the importance of thoughtful spending.
2. Role model cost-conscious behaviour
It’s essential to demonstrate cost-conscious behaviour and set the tone from the top. It all starts with your spending habits and ability to manage money well, remember?
So, if you master personal finance principles, you can genuinely lead by example and promote a culture of careful spending in your organisation.
3. Structure incentives
To ensure managers’ goals align with the long-term success of your business, incentives should be linked not just to the objectives of this year but also to strategic goals. This way, you can prevent employees from concentrating too much on short-term results.
For instance, you can introduce a share options scheme. Under such a scheme, employees could buy company shares after a set period, say three years. This incentive would encourage them to focus on the business’s long-term growth.
4. Leverage technology
You need a convenient way to monitor costs without spending much time entering data into spreadsheets. Consider affordable, subscription-based business intelligence tools, such as Power BI. They let you build dashboards and reports that simplify data analysis.
Also, check whether your accounting software integrates well with your bank. This will help you identify any issues early and maintain proactive financial control.
5. Streamline expense approvals
To prevent excessive spending, set transparent guidelines on how and who reviews and approves expenses. Specifically for larger items, define a threshold requiring an additional approval level.
To maintain accountability across your business, make sure these policies are clear to all employees and implemented in your financial management systems.
6. Review performance regularly
Budgeting is a powerful tool for managing finances.
It’s important to implement a structured approach to reviewing the performance of your budget owners. For example, you could arrange monthly meetings to go over expenses across various categories, identify variances, and evaluate KPIs.
Note. Ensure your KPIs are both financial and non-financial. This will encourage managers to focus on the quality and effectiveness of their strategies rather than solely on financial results.
Final thoughts
Yes, putting cost control processes into practice might seem hard and not always popular.
But keep in mind that it’s not just about improving profitability — these steps help you avoid having to cut costs in ways that can hurt. By managing your finances wisely now, while things are good, you’ll be well-prepared when they get ugly.
