OPEX or Operating Expenses is one of the least sexiest topics in Business. However, it is one of the most important. The reason is pretty simple. Every dollar of OPEX comes straight out of profit. So, the easiest way to grow profit is to save a dollar of OPEX. However because this is not a sexy topic, many Business Owners ignore looking at OPEX. I will give you a view to what is in OPEX and then why you should care about it.
All your Operating Expenses that are not part of COGS (see last week’s post) are part of OPEX. What is not is financing expenses or taxes. That is why the result of removing OPEX from your Gross Margin is called EBITDA (Earnings BEFORE Interest, Taxes, Depreciation and Amortization). So, think of the result as the Operating Profit from your business. This is a great measure to know if your business is operating effectively or not.
The first reason to care about OPEX is that it is important to look at when business is good. Why is that? Well, victory tends to cover up a multitude of sins. Being inefficient will only come back to your business in hard times. The problem is that you will then have to fix things in a problematic way. Now if you are just wasting money, that is one thing. But many of your expenses are built into your Business Processes and you need to change those processes to make a significant difference. To do so, will cost some time and money. That time and money is easier to come by when things are going well. So, it is always time to think about what you can do better. There is a term called “Zero Based Thinking” which people use to describe a thought process where nothing is assumed. Do you really have to do things the way you do or is it just inertia? At least some of your competitors will be looking to improve the way their business works. Can you afford not to? Now, you won’t make grand changes all the time. Small changes add up as well. But be on the lookout for the way to make your business work better.
The second reason is that OPEX naturally increases every year due to inflation. Think about what is in OPEX. Most of it is based around people’s salaries and they want raises. Benefits increase in costs every year, especially health benefits. Insurance rates go up. So does rent and utilities. When I was at AFC, we used to estimate that OPEX went up 7% per year if we did nothing. That means that either we have to sell a corresponding amount of more stuff to get the money back from revenue or we have to spend less or both. Both is the easiest solution. Think about what could happen if you sold 20% more stuff but needed no new people to do so? It would likely mean an increase in profit, but probably not as much as you would like.
As an Executive, it is this balance between growth and profitability that you need to keep your eye on. It is easy to let the two sides of the coin (expenses and revenue to get out of balance). You can not cut your way to revenue growth, but revenue at any cost is a way to go bankrupt. That is why it is important to be efficient and the best way to track that is OPEX. For example if you are trying to grow by hiring more Sales people, you need to ensure that they have the same level of quotas as existing people. At some point, you will have reached your natural audience and more people won’t help. You can see this in many companies where Sales and Marketing expenses grow faster than Revenue does. If the company is entering a new market or territory, this is natural. But if this becomes the new norm, there is a problem.
So, I hope I have made OPEX important if not sexy!
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