80/20 Expense Analysis

The term 80/20 expense analysis is not one you hear every day, but it is a concept that can be highly useful to managing and improving a business.

All Things Are Not Equal

Over the years I have performed countless analysis of expenses for companies. When I first started working it was standard fare to compare the current month or quarter or year to the same period last year or to the budgeted numbers. That was a good start but left at that (and it often was) really was not enough to make any meaningful decisions. In fact, as I looked back years later I realized that management rarely did anything with the analysis. Of course I’m not blaming them as perhaps they didn’t know what to do with it. I’m also not blaming myself as I was just doing what I was told to do and really nobody ever indicated a need to go deeper. Yet, I later realized that something was missing in the process. By that I mean that there was a missing emphasis on identifying the expenses that were having the biggest impact on results.

Some Background

As you know, not all things are created equal. That holds true when it comes to expense analysis. Obviously some expenses are so small that they hardly deserve a second look; or do they? Others are so large that we sometimes focus on them only and miss the boat in the process. Let’s use the following simplified example.

sample company expenses

The Unchangeable Big Expenses

As you can see in the above example, Officers Compensation, Salaries and Wages, and Rent are only 30% of the line items yet are almost 70% of the total expenses. However, it may well be that these are items for which there is little or no opportunity to reduce. So, for our purposes we’ll skip them and only consider the remaining seven expense items.

A Deeper Dive

When we look at the remaining expenses they total $117,150 for the current year and $106,300 for the prior year. Now here is the opportunity that is often missed if we don’t get past the first few big items. A deeper dive into 80/20 expense analysis is in order. If you do this you will see that of the remaining expenses, the first two, Employee Benefits and Business Insurance are just over 28% if the seven lines yet over 70% of the total of these seven items. These are expenses that it may be worth examining further to see if reductions can be made. Ask a few simple questions. Can you get a lower cost health insurance plan that still provides the coverage you want? It is amazing how easy it is to overlook an opportunity to cut in this area. Now you may look at business insurance and see it did not increase from the prior year and just assume that is is fine. Again, ask yourself some questions. When was the last time you shopped your coverage? Do you have more coverage than you need? Does the current insurance coverage have information on your company that is still accurate? You can see more on how this can make a big difference in Shopping Insurance.

The Little Things

I don’t want to leave this without addressing another thing that is often overlooked. Look again at the line item Miscellaneous. Yes, it is not that big compared to other items, but it did increase 60% and it is large enough to make us wonder just what is in it.

When reviewing expenses 80/20 expense analysis is a highly useful tool, but as you can see from the above expense examples of Business Insurance and Miscellaneous that you sometimes need to look a little closer or from another angle.

If you want to know more, contact AimCFO – Contact

As always, your comments are welcomed.

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