How to identify and reduce the costs and risks of your small business.
The costs and risks your business holds may not be entirely clear, however, we’ll help you uncover challenges that may be keeping your small business from greater margins and profitability.
As an entrepreneur or founder, you’re no stranger to taking chances or living with risks others might be too uncomfortable to assume. Go, you!
However, too much risk or too many costs can put your business in jeopardy, especially when you’re unaware of the consequences or impact. To bring you the clarity you need, read and discover a few costs your business may be incurring—plus some risks you can control.
With this knowledge, your business will be more profitable, sustainable, and easier to run, giving you a big advantage over both the market and your competitors.
Have a question? As you read, don’t hesitate to contact our team with questions, especially as they relate to your specific business goals or challenges.
When you read the word “costs”, your brain may jump immediately to your finances. You may be expecting tips on how to negotiate down your rent, material costs, or payroll, but you won’t find that here. While these costs are important, there are other costs in your business that are more foundational.
Below, you’ll find several different cost categories, plus cost concepts that can guide your planning or decision making, including:
These are costs you’ve already paid and cannot recover, like last month’s payroll or last year’s interior design overhaul. This cost connects to an important concept all business owners should be aware of: the sunk cost fallacy.
In other words, this fallacy leads you to try and make up for a “wasted” investment, throwing even more money and time at it. For example, you hired an accountant who made several costly mistakes and, even after spending thousands of dollars on training, they continue making the same errors.
Don’t worry about the salary costs you’ve already paid—find a solution and move on. Doing otherwise would be an example of following the sunk cost fallacy, which costs you even more in the end.
When you make a choice, you’re also not choosing something else—and that has a cost.
Opportunity cost is, in investment terms, the difference between the return on your choice versus the alternative—and it’s good to be aware of as you make dozens of decisions each day.
For example, if you choose to pay $100K for an equipment upgrade, you give up the chance to invest that $100K into new software. If your equipment upgrade achieved a higher ROI than the software, that’s fantastic—but realize you still had to “give up” the benefits of that software in order to achieve the benefits of the equipment investment. You couldn’t direct the same money, at the same time, to both efforts.
This type of cost can be difficult to assess, which is why many companies bring in an expert to help plan and execute larger investments in equipment, expansion, or capital upgrades.
Although a more straightforward concept than sunk costs or opportunity costs, variable costs are difficult to control and navigate.
Why? As the name implies, these are costs that vary. Unlike your monthly loan payment, these costs change, making it a challenge to forecast and meet financial targets.
For example, imagine your material costs are regularly impacted by global tariffs, weather, supply chain delays, and labor shortages. In this case, it’s tough to know whether you’ll pay 20% more, or less, for your materials this month.
Getting a handle on variable costs is key.
Even if you can’t forecast them with absolute precision, your financial plans, cash flow strategy, and more should take these variations into account. Otherwise, you will likely find yourself without enough cash or margin at one point.
Also known as operating expenses, or opex, these costs that can’t be traced back to a single product or action, like your utility bills or your rent. These are costs across the entire business, unlike R&D for a certain product or a specific employee’s salary.
Operating costs are worth calling attention to because, unlike other costs, these costs cannot be avoided. Without them, the business won’t function, so it takes specialized skills to reduce or optimize them if you’re trying to run a lean company.
There are costs you can control, hence the appropriately named controllable costs. These costs can be increased or decreased—though with potential consequences—for things like R&D, business travel, training, tax payments, and employee salaries.
Importantly, these are short-term costs, not long-term expenditures. These typically affect more immediate spending, requiring significant oversight so that these costs stay under control.
With a deeper understanding of costs your small business incurs, now we can explore the risks that your company is impacted by—some a direct result of the costs we mention above.
No risk, no reward, the saying goes.
But reducing your business risk will actually help you reap rewards from your organization. Becoming aware of these risks and their solutions helps your business achieve more.
Unfortunately, this first set of risks is outside of your control: politics, natural disasters, war, pandemics, and regulations all have a significant impact on your company with little you can do to address or prevent them.
But don’t treat these risks as something you cannot plan for.
You can be better prepared to respond to macro risk by being proactive and thoughtful, anticipating how a change in interest rates or overhaul of regulations could impact your business. Instead of being caught unaware when minimum wage increases or surprised when loans become harder to get, you’ll be far less reactionary and perhaps already have a strategy in action.
Yet if balancing running a business with forecasting for potential issues is beyond your bandwidth or skill set, there are professionals who do this for businesses like yours. Not only will you free up time, they’ll bring deep knowledge of the numbers, historical data, and broad macroeconomic information for more informed decision making.
Many business owners assume the greatest tax risk is getting a strongly-worded letter from the IRS, stating you owe more than you paid.
But tax risk is like an onion: not only can it make you cry, it contains layers of other risks, including those that can sink an otherwise successful organization. This includes reputational risk, or the damage to your reputation if it becomes known your business has perceived tax issues, making it harder to access credit or preferable vendor terms.
It includes legal and regulatory risk, too, if your accountant forgot to file on time, or claimed far too many tax advantages for the business.
The risk of an audit is not only in the fine, but also in the time and focus lost responding to the audit.
Finally, there’s the risk of paying taxes as an unavoidable operating cost, not the variable cost it should be. Business owners who cut a check each quarter are missing massive opportunities to optimize their tax burden, better plan their payments, and strategically time income and expenditures, impacting everything from their margins to their cash flow.
Fortunately, a tax strategist can help eliminate these challenges and risks to your business.
While it’s wonderful to have an employee who is like your right hand, this actually introduces significant risk to your business.
Not only do they have outsized control over your business’ success, your reliance on a single person makes you less able to control costs or negotiate their salary, bonuses, or benefits. Plus, it limits your exposure to new ideas or expertise; what if you need more diverse skills as the business changes?
This is why businesses often hire external experts, like a virtual CFO or an outsourced bookkeeper: they reduce the risk of relying on a single person, plus get seamless access to more skilled or qualified experts, benefiting from a larger pool of knowledge. As their business evolves, so can the type of expert or experts they rely on.
Importantly, this also eliminates the need to pay costly benefits, holiday bonuses, PTO, taxes, and other fixed expenses. Should your business weather a downturn, being lean and responsive will be key.
Despite the costs and risks your small business faces, these are well-known by skilled bookkeepers, CFOs, accountants, and audit specialists whose decades of experience add up to significant risk- and cost-reduction.
If you’re determined to make your business more profitable, sustainable, and easier to lead, connect with a member of the LedgerWay team.
We’ll answer your questions, provide actionable recommendations, and help you identify or troubleshoot your most pressing finance challenges so you can get back to business.
National Business Development & Sales Manager
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