THE BLOG
03/22/2012 11:51 am ET Updated May 22, 2012

A Tried-and-True Tool for Entrepreneurs: The Compounding Effects of Smart Cost Control

It's not fancy or trendy. It's a boring topic at cocktail parties. Seldom is it covered in M.B.A. programs. But this tool will free up buckets of cash flow and at no expense to business owners, and move your bottom line skyward.

The "it" I'm talking about is cost control. Get good at it, make it part of your business culture, and your chances for success jump like a Big Ten center going for a rebound.

Are you dozing off yet? See, that's the problem. Cost control sounds so one-dimensionally simple it barely seems worthy of managerial-level discussion. Maybe that's why it rarely gets the attention it deserves. Developing trendy products, or the art of selling, seem to attract attention more than running an efficient operation. That's fine except for one thing: Without an underlying squeaky-tight operation, no hot product will keep you in business, let alone pay for your retirement.

When you understand the impact cost control can have on your cash flow and business profitability, I guarantee you will be a lifetime believer -- because cost control reaps rewards on many levels.

Level one is the classic penny pinching on paper clips. It only saves the aforementioned few pennies, but it begins to establish a mindset. After all, how can you save $150,000 on IT contracts if you haven't negotiated smaller savings along the way? You just won't have the mindset or skills to do the job.

But develop the right mindset and skills to achieve savings at every transaction and, as the business grows, savings are vastly compounded and serious cash flow is freed up. Add these up over a period of years and it is like getting a free loan that doesn't have to be paid back.

Before you turn up your nose at such simplistic thinking, consider this: Not developing this skill is like running machinery without oil; over a fairly short period of time, you just won't get the results you could have...

If you are an extrovert better suited to selling your product or service than administering cost control protocols, find someone qualified to pinch hit for you. The right person can more than make up for his or her cost.

I once had a tour of a friend's large catalog business. Halfway through the tour I was introduced to a new employee, who was paid $90,000, in 1988, as a staff consultant. I asked how the owner could afford to pay this person so much, and the owner replied: "The third day on the job he saved us $90,000 on a printing contract." I can only marvel what he saved for the remainder of that year. By bringing in someone from a larger company they were able to buy into the tricks of the trade that only an older, more established firm had already figured out.

Now let's take a look at two hypothetical situations -- a terrible cost control big organization, and a sharp-as-a-tack small business.

For the big business, let's take the obvious choice -- the U.S. Military. Not only is it systemically terrible at cost control, but it has every incentive to stay that way. Each branch needs to spend all they can so they can justify larger funding for their next fiscal year. The generals in charge like to brag about the bigger budget they just landed, not the money they saved. What kind of a wimp would try to save money inside the U.S. military?

For the small business arena of cost control we can walk to just about any busy street corner and pick any family-owned business that has been around for at least 10 years. You can bet your postage meter that the owners of that business really understand the compounding effects of cost control. They make every expenditure cost efficient by negotiating for extended payment terms, relative to calendar days when payment is due; or by getting a cash discount for paying within 10 or 15 days; or by getting some other compensation from the supplier, such as free delivery or an advertising allowance, and so forth.

A good entrepreneur owner-manager sees cost control as an unavoidable toll booth with a hidden bonus: unlimited options to negotiate performance incentives. The small business owner knows he has to pay for goods and services he purchases, but for every block of cash committed he or she will figure out a way to get 2-, 4- or maybe even 7 percent of that back via one or more of the aforementioned methods. With that freed-up cash flow the business can be grown to do the same thing on a larger and larger scale. It's an invisible source of cash for a business' engine. Since 67 percent or so of new business start-ups fail within the first 10 years, that slice of freed-up cash can be a critical component.

For example, consider two identical hypothetical retail companies, each doing $450,000 in sales in year three. Company A is so-so at cost control; Company B is a whiz. At the end of the year, Company A's C.P.A. firm calculates against $450,000 in net revenues, they had $463,500 in expenses, and thus had lost $13,500. Not bad for a small investment and only three years in business. And since they were growing at 25 percent a year, the owners were optimistic.

Unfortunately, their bank wanted to see more equity in the business and wouldn't increase their credit line. Company A would have to hang tight, hoping that higher sales would eventually bring profits and positive cash flow.

Company B, on the other hand, found ways to save 3 percent of its costs. Against their $450,000 of net revenues, they had $450,000 of net expenses. They had broken even in year three, and were also growing revenues at 25 percent per year. Their bank saw a brighter future and was willing to slightly increase their credit line. This gave Company B a little more fuel for their fire. Now it could grow a little faster and its cost control expertise would be applied on a larger scale. It would pull away from Company A for good.

All other things being equal, imagine how different the financial statements for these two companies would be 10 years from now, since Company B would be adding 3 percent or more to their bottom line year after year.

In Chapter 21 of my book, Chicken Lips, Wheeler-Dealer, and the Beady-Eyed M.B.A.,: An Entrepreneur's Wild Adventures on the New Silk Road, I tell the wacky story of my own company's foibles with cost control as it grew from a ragged start-up to a mature retailing engine, becoming a three-time INC. 500 company along the way. Bankers went from avoiding me, to courting me. One of the key secrets was being efficient with costs and operations, and understanding the underlying expense numbers on our income statements.

Doing anything else is just leaving money on the table. You wouldn't do that in a small-stakes card game or sports bet, so why is it that so many small business entrepreneurs leave money on the table when their family livelihoods are on the line?

The answer, of course, is that cost control is often misunderstood; the right mindset is rarely in place. Without it, small business entrepreneurs are like ships with a crooked rudder and inaccurate compass; oblivion is just a matter of time.

With cost control skills you can increasingly optimize the effectiveness of your start-up and credit line capital, and the odds of your long term success.

Frank Farwell is founder and past president of the WinterSilks catalog (www.wintersilks.com). His book, "Chicken Lips, Wheeler-Dealer, and the Beady-Eyed M.B.A.: An Entrepreneur's Wild Adventures on the New Silk Road," was nominated for the Financial Times/Goldman Sachs Best Business Book of the Year Award, is sold in most English-speaking countries, at Amazon.com and frankfarwell.com.

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