Analyzing and understanding your costs is the first step before you cut anything. These principles apply anytime margins are under pressure, whether that's a recession, rising tariffs, or just a rough quarter. If you don't understand your costs' behavior, you risk slashing and burning your way into consequences you weren't expecting.
Separating COGS from expenses
The first thing to understand when analyzing business cost structures is the difference between COGS and all other expenses. Income minus COGS gives us gross profit. Businesses operate off their gross profit, not sales. All other expenses after gross profit are considered overhead. COGS is critical for sales, whereas overhead expenses are not necessarily critical. Therefore, when you first consider cutting costs, you should look at overhead expenses.
Because your business should operate and make decisions off gross profit, you must accurately calculate and record COGS. If your COGS is not separated from all other overhead expenses, you lose visibility into what is happening in your business and poor decisions can be made. It's absolutely critical that you separate your COGS.
Read more about accurately calculating and recording COGS.
Understanding fixed vs variable costs
Fixed costs:
- Stay the same at any revenue level and are hard to change
- Good foundation during good times, an anchor during bad times
- Ideal during times of growth
Variable costs:
- Vary with production and remain agile
- Provides great agility
- Ideal during times of instability
When you are considering optimizing costs, here are some ways to move fixed costs variable costs:
- Change salary employees or positions (fixed) to hourly (variable)
- Move from in-house staff (fixed) to contractors (variable)
- Stop renting a warehouse (fixed) and find a 3rd party logistics company (variable)
- Change annual subscriptions (fixed) to monthly subscriptions (variable)
- Move from a fixed fee marketing contract (fixed) to a marketing agency that charges based on sales (variable)
Determining regular versus seasonal expenses
Another way to analyze your business cost structures is to separate regular (monthly) versus seasonal (annual) expenses. Monthly costs include payroll, marketing ads, monthly software subscriptions, rent, and utilities. Annual costs include business insurance, marketing events, annual software subscriptions, and bonuses.
Monthly and annual costs need to be separated because monthly are usually the costs you should look at first. They are easier to adjust up and down. Annual are bigger costs that you can often negotiate. Understanding when they happen is important to make sure you cut annual costs that aren't needed.
Identifying key expense categories
Understanding your costs requires good accounting that not only accurately categorizes your expenses, but separates them by areas, such as department. In QuickBooks Online, you can use class to divide costs by department. Understanding your costs in different dimensions will help you determine how to optimize them.
Also understand what costs are important at different times in your business. Are you currently surviving, maintaining, or growing? Different costs are essential depending on your situation. For example, hiring tools and staff would be essential during growth and non-essential during survival mode.
Finally, determining mission critical costs is important. If you are in the terrible situation of needing to terminate employees, it's not necessarily the highest paid salary employees that are mission critical. Is there a certain employee that manages top clients that you can't lose? Do you have an employee who is critical in running a team? These examples are for employees, but you can use this idea across other costs.
These are the kinds of judgment calls that come up again and again when businesses start digging into their cost structure, so here are answers to the questions we hear most often.
For more on optimizing costs, read Cost Optimization Strategies: How to Know What to Cut (and What to Protect).
Frequently asked questions
What's the difference between COGS and overhead?
COGS is the cost directly tied to producing or acquiring what you sell. Overhead is everything else. Income minus COGS gives you gross profit, which is the number your business actually operates off of, not total sales, so COGS needs to be separated out accurately before you can make good cost decisions.
Should I look at fixed or variable costs first when cutting expenses?
It depends on your situation. Fixed costs are a stable anchor during good times, while variable costs give you agility during unstable periods. If you need flexibility, converting fixed costs to variable ones, like moving from salaried staff to contractors, or from a warehouse lease to a 3PL, is often the better lever.
Why does it matter whether an expense is monthly or annual?
Monthly expenses are usually easier to adjust up or down quickly, so they're the first place to look when you need fast changes. Annual expenses tend to be larger and negotiated less frequently, so understanding their timing helps you catch and renegotiate them before they auto-renew.
How do I know which costs are actually mission critical?
It's not always the most expensive line item. For payroll specifically, ask whether a person manages key client relationships or runs a critical team, rather than just looking at salary. The same logic applies across other cost categories: the question is impact, not price tag.
What's the best way to categorize costs for better analysis?
Break expenses down by department or area of the business, not just by type. In QuickBooks Online, this can be done using class tracking, which lets you see costs in multiple dimensions and spot exactly where to optimize.
Turn cost analysis into a real strategy
Knowing the difference between fixed and variable, mission-critical and safe-to-cut, only helps if your books are actually structured to show it. LedgerGurus can help you build the department-level tracking and clean COGS separation that make real cost structure analysis possible, then bring CFO-level insight to help you act on what you find.
