If you have an MBA degree, you probably studied financial management, which means that you can tell costs from investments. Both are typically seen in different forms of basic financial reports – P&L and cash flow. You are certain to find costs in P&L and investments in cash flow (or in the balance sheet).
But what if we look at costs and investments from a different point of view? From the point of view of a businessman who has to make his everyday decisions about what is worth spending money on and what is not. Businesswise, is there any difference between the two financial terms?
Sometimes it is very easy to distinguish costs from investments. For instance, if you have just paid 1M for an advertising campaign, you probably consider it as an investment. But let’s imagine that your assistant comes to you to complain about his (or her) chair, which is too old and uncomfortable. How will you refer to money spent on the new one – as a cost or as an investment?
Or what if one of your best managers comes and says that he (or she) has just got a fantastic offer from your main competitor, and you decide to raise his (or her) pay to keep them from leaving the company? Is it a cost or an investment? According to your accounting records, it is a cost. But if you are not an accountant, you have to think differently.
Some expenditure seems inevitable. You have to pay rent. You have to pay salaries to your staff. But as long as you think this way, you will never be able to reduce those costs, not even some of them. Some companies survive without offices (but not always successfully – some years ago Marissa Mayer, a CEO at Yahoo, ended the program encouraging staff to work at home and brought a great deal of them back to the office). Some companies tend to replace human beings in factories or even in offices with smart machines. Should you do the same? Is there a good, rational way to make such decisions?
It exists. First of all, you have to learn to look at all (or, at least, almost all) costs as investments. Why does my business need those investments? How will I get a return on those investments? When? In what form?
Let’s get back to the example with the chair. What is going to happen if you say no? Will your assistant leave the company? Will your refusal make her (him) upset, thus affecting their motivation and, consequently, their productiveness? Will the image of your company suffer from your customers’ impressions of the chair if they see it?
Of course, that example with the chair is an exaggeration. If you are a CEO of a company, you should not be thinking about chairs. Instead, you have to think about more global and conceptual things, such as the general approach to expenditure. How should you decide whether some things are worth spending money on? Which criteria should you use to distinguish useful expenditure from useless? What should you do to make your decision making (when it comes to costs) swift and efficient?
First and foremost, you should have your strategic objectives specified very clearly. Your objectives are not just distant goals you strive to achieve in the indeterminate future. They are priorities which help you answer a lot of everyday questions, including ones concerning expenditure. For instance, your company is going to be a market leader by being the most innovative business. It means that you really should say yes to all the expenses for market research, R&D, buying new equipment, etc. But if your company is implementing a cost leadership strategy, you have to think twice before spending every penny.
If your success is based on “human capital,” you have to care a lot about your staff. Maybe they need some more time to rest during the day? Do they deserve a flexible work schedule? Will they be more productive if they work at home? But if your business is a sweatshop, your office may not be the most comfortable place to work, the schedule may be rigid, and the general conditions may be tough.
But good, clear objectives are just half the solution. You also have to work out (and describe at length) all the methods, i.e. the way you’re going to reach them. The more detail the better. It will let you develop your strategic budget and find out precisely how much money you may safely invest in different aspects of your business. Sometimes you will have to save money, not spend it on the things you may have considered really important – just because you don’t have enough money even for more indispensable things.
But if you understand your priorities and have enough money to cover all your expenses, you should always ask yourself (before approving payments) – are those investments really important for my business? How will I get that money back? When? In what form? Will those investments really move my business forward?
This means that you should seriously change your approach to expenditure. Typically, we tend to look at it as something that decreases our income. We think of expenditure when we deduct it from our revenue to figure out how large our net profit is. And as we do so, we often think that we should cut some expenses to increase our profits. But cost reduction is not always a good way to make our business stronger – sometimes it has the opposite effect.
What is really important for your business? Which kinds of activities bring you more customers? Which kinds of activities will make your customers happier? What can help you gain a genuine competitive advantage? Invest in what may (or at least what you believe may) help your business get stronger first.
If you have to make the difficult decision of whether you should spend (or “invest”, as it’s better to say) significant money in something, just take the trouble to think about how much (and what exactly and when) you will get in return. And don’t just think – write your thoughts down. And in the future, just check whether the result met your expectations or not. Doing so continually will help you calculate expenditure more accurately. Soon it will turn into a very useful habit.
So, just to recap:
- A business doesn’t have expenses – it has only investments.
- Every investment should return some kind of profit (not necessarily a financial one).
- You should try to estimate this profit, at least roughly, before you spend money.
- You should think of any expenditure as an investment and invest in the things which make your company stronger, things which help you gain a competitive advantage.
- Try to analyze all your successful and unsuccessful investments in order to improve your calculation skills.