Flexibility and nimbleness play an important role into
sustainability, and the survival of a business when impacted by an
economic shift, or other macroeconomic event that inevitably occurs from
time to time. Keeping your cost a variable will allow you to make quick
adjustments that can help you preserve cash, and to keep the doors open
while revenue is down. During tough economic times many businesses
fail, and further end up closing the doors because they run out of cash,
and in most cases are not able to raise the additional capital required
to keep going.
Variable costs fluctuate with revenue generating
activity, such as labor, materials in the case of manufacturing,
equipment repairs and maintenance, etc. If revenue in your business
declines, you can expect that most of the variable cost will follow
suit. Lower revenue will require lower labor, while the decline in
demand for your product will not require the purchase of materials. Your
equipment will get less wear and tear, and therefore will not require
nearly the amount of maintenance that would be required when running at
full capacity.
Fixed costs on the other hand are not as nimble as
variable costs, given that changes in revenue will not impact fixed
costs to the degree that it would impact variable costs. Real estate
space, administrative staff, telephones, and utilities can run constant.
Month-to-month renting of facilities vs. long-term leases is one way to
keep this fixed expense a variable if you needed to change your venue,
and preserve cash. Determining the amount that should be kept as a
variable depends on your industry and how your business can be impacted
by certain economic events.
At this point you should start seeing
the importance of having cost act as a variable vs. having cost fixed,
given that one offers more flexibility than the other. Granted there is
businesses in certain industries that will not be allowed to keep their
cost a variable, mainly manufacturing that require heavy investing in
the purchase of facilities, as well as expense machinery. Regardless of
your industry, labor for the most part can be a variable, unless it is
administrative, in which case will act more as a fixed expense given
that reducing your administrative department can have an adverse impact
on your business.
A week economy often requires a reduction in
cost overnight, and you cannot afford to have your business experience a
reduction in revenue, while still maintaining the same expenses. Such a
move will eat into your cash reserves, and without taking action can
push your business into insolvency.
