The alternate route to profits

Every business strives to earn more and more profits. Without profits, it is next to impossible for a company to survive in the long run. This is because profits are the most important source of cash flow and funding for a business. There are two ways in which a company can increase its profits, either by increasing its sales or revenue, or by reducing its expenses or costs.

As a company's revenues increase, there are some expenses which increase with it and some that do not. For example, a company might have to pay for additional commission or need more raw materials for additional sales. These costs increase with additional revenue and are classified as variable costs. On the other hand, the rent paid by the company may not increase with an increase in sales. This, along with employee salaries, insurance, and rental lease payments are some of the fixed costs for a business. Thus, the penultimate goal of every business is to increase its sales or revenues by an amount greater than increase in its expenses (either fixed or variable) in order to generate higher profits.

However, it's easier said than done. We have seen companies across the globe cut down on their expenses due to the pandemic. The pandemic has severely affected their revenues and lowering their expenses has helped them to either maintain their profits or, in some cases, to limit their losses. For many of these companies, this cut-down on expenses might be temporary as operating at such low costs may not be sustainable for them. However, there are some companies which have been successfully lowering their expenditure for many years now. These companies may have delivered flat to high growth in their revenues but their earnings growth have outperformed their revenue growth on the back of lower costs. This, in-turn, has resulted in higher margins and higher profitability.

For example, P&G has seen its revenue increase by only 1.2 per cent annually in the last five years, whereas its earnings have grown at an astonishing rate of 37 per cent annually during the same period. The company's expenditure-to-sales ratio has also come down drastically to 74 per cent as compared to 98 per cent five years back. Thus, it is very prudent to invest in companies which have a tight control over their costs as it helps them to increase their earnings. Here, we look at the companies that have lowered their expenditure against their revenues continuously in the last five years: