A common term in finance but one rarely used in business is "plowback.
" Plowback is taking all or a portion of retained earnings (profits) and essentially plowing them back in the company for working capital (such as inventory and material purchases), overhead (such as marketing or R&D) or capital purchase (such as new plant and equipment) - items that are usually financed through outside capital acquisition such as debt or equity.
With capital raising options dwindling by the day, finding additional cash flow within the business has become the only surviving factor that many small, growing firms have left and should, regardless of the economy, be something that all businesses make a solid practice of.
Think about it this way: Let's say that your business earns $150,000 in revenue each year and that it expenses that same $150,000 in direct and fixed costs - leaving the company with little or no retained earnings.
Now, this year the company needs to purchase a new piece of equipment costing $15,000.
This new piece of equipment will improve the company's efficiencies and reduce its overall direct costs by a combined net of 5% annually over the next three years (the useful life of the equipment).
This means that after the equipment is purchased, changing nothing else, the company should be able to realize a net income (profit) of that 5% or $7,500 per year.
While not a lot, much more that what the company has been realizing to this point.
But, the company does not have the cash on hand to make this purchase and thus, has to borrow the $15,000.
Now remember, the company is making no profits at this time - neither net profits nor operating profits - profits that would be used to make the payments on the loan.
So, if (and that is a big "IF") - if the company can get a lender to loan those funds it would eat into that 5% saving as long as the loan was outstanding.
Let's say that a lender did agree and made a loan for 36 months at 10%.
The loan would cost the company $484 per month or $5,809 per year.
Take this from the $7,500 in savings and the company is left with a mere net profit of $1,700 per year.
However, let's say the company took a different approach.
In this case, the business scrutinizes all of its costs - line item by line item - and finds an average 10% savings on its expenses: It found that it could alter its workforce using part-time or temporary workers instead of paying full-time employees to be idle between jobs.
It re-negotiated its lease into a longer term contract at a lower monthly rate.
It leveraged bulk inventory and material buying as well as the timing of its purchases to reduce its material costs.
It sought better, more targeted marketing avenues that provided improved results at a lower cost.
The list goes on.
In fact, the company sought and found ways to reduce the expense of all its cost items finding a net savings to the business of 10% annually.
Now, not only will the company have a net profit or retained earnings of 10% (or $15,000 per year) but could use those funds to buy the equipment outright.
Thus, the business purchases the equipment (without additional loan costs), realizes the 5% in savings from that purchase for the next three years and STILL continues to realize the 10% cost improvements for the life of the company.
This is a win/win for the company.
If we compare these two scenarios over the next three years, we see: In the first scenario, the company realizes a net $5,076 in benefits over the three years then reverts back to the way it is today (no net profits).
In the second scenario, the company realizes the 5% savings from the equipment ($7,500 per year) as well as the overall 10% cost savings in the business ($15,000 per year) for a total three year realized benefit of $67,500.
Big difference! Plus, the 10% in overall business savings will continue long past the three year useful life of the equipment.
Even if the business could not find all those expense savings (maybe just half or a third) - those savings will go a long way in reducing the amount of money the company had to borrow as well as continue to bring more net revenues into the firm for years to come.
Finding cost savings in your business is not rocket science and does not require an advanced business degree from an Ivy League school.
You set a cost saving goal - then simply manage your business to meet that goal.
You set your mind to open and run a business - now set your mind to better manage that business (to your benefit).
What is the worse that can happen? You just might find enough savings within your own company to finance it to that next level of success.