The Importance of Cost Management in Business
Effective cost management is necessary in today’s business world for a company to remain sustainable and profitable. But what exactly is cost management? Most experts agree that it is “a systematic treatment of costs that begins with cost estimation at the early stages of a product or service and follows through with activities that influence costs and better decisions in the later stages of the product or service life cycle.” In this way, costs are kept under control without allowing the quality of goods and services produced to suffer.
Techniques for Controlling and Reducing Costs
Businesses employ cost control techniques to control and reduce their costs. These techniques enable organizations to identify areas where costs can be reduced, often without impacting the quality or productivity of goods or services produced. Some of the cost control techniques used by businesses are quite straightforward. An organization might, for instance, maintain a simple list of all expenditures incurred by the business to identify necessary vs. discretionary spending. On the more complicated end of the spectrum, as I’ve noted, some organizations use sophisticated budgeting systems or software. By and large, though, the techniques used by businesses to control costs aren’t that complex.
Profit Margins and Cost Control
Increasing profit margins starts with controlling costs. If a business can do that, it already has a leg up on being profitable. No clear path leads to profitability other than the one that avoids or reduces costs. When a business looks at how much these costs affect its bottom line, it often can find a clear way to reinvest profits in the business for growth or to increase the value of shares it has sold to its investors.
Managing Costs in a Competitive Market
In a saturated market, managing costs effectively allows businesses to offer lower prices and thus attract a larger share of the customer base. In our cost-conscious world, a consistent focus on controlling costs enables even a mediocre company to maintain at least decent profits.
Budgeting as a Key Cost Control Technique
Budgeting is one of the most essential techniques for controlling costs. It lays the foundation for a business’s relationship with its money—both coming in and going out. The Revenue and Expenditure Plan (the Plan) is the business’s financial plan. It outlines the expected earnings and outlays over a specified period. The Plan is the business’s money blueprint. It shows where money will come from and where it will go, essentially serving as a business’s financial road map. Whether for a start-up or a going concern, the money blueprint is critical for management purposes.
Analyzing Costs and Inefficiencies
When businesses look at their real costs contrasted with their standard costs, they can better see their inefficiencies and their potential for improvement. The folks who do this kind of work are then called analysts, and what they do is called variance analysis. These analyst-type people assess the differences between what was planned financially and what actually happened.
Activity-Based Costing (ABC) and Lean Accounting
Allocating overhead costs in ABC starts with identifying the main activities that take place in an organization. Required for each activity is the identification of the costs necessary to carry out that activity. Then, required for each activity also is an identification of the drivers that associate the costs incurred with the products or services being offered. Lean accounting encourages, first and foremost, thinking in value stream terms when identifying the activities that make up the key processes by which the organization serves its customers.
Lean Methods for Reducing Waste
Organizations that want to enhance quality and reduce costs can take a page from the Lean playbook and cut the wastes of overproduction, excess inventory, and poor workflow. The Lean approach seeks primarily to eliminate these three types of waste. By eliminating them, organizations can not only stop losing money but also find ways to enhance quality. Lean methods of cutting waste work equally well in service and manufacturing environments, and by 2010 they had gained so much popularity that 95 percent of U.S. manufacturers had adopted some form of Lean.
Cost-Volume-Profit (CVP) Analysis
Businesses use CVP analysis to get a grip on the interplay among costs, sales volume, and profit. That’s because it delivers an understanding of how changes in cost, sales price, or volume affect a business’s profit. Thus, CVP analysis forms a basis for making pricing, production, and product mix decisions. And, hey, there’s nothing wrong with using it to make your negotiations with suppliers more effective!
Steps for Successful Cost Control Implementation
For successful implementation of cost control techniques, organizations should take the following steps: Set clear targets: Clearly defined and well-communicated goals are the foundation of any successful cost control program. Stakeholders at all levels must understand and buy into the process if it is to succeed. After all, cost control at its best is almost a culture, and you want everyone in the organization to sing together.
Monitoring Performance and Analyzing Results
Keep an eye on and gauge performance: Make it a point to follow the financial performance of your organization against accepted standards and established budgets. Look for trending results and investigate areas that seem to be performing below your expectations. Analyze the numbers: Cost control relies on accurate and timely information. Use computer programs and personnel to help ensure that your cost control system results in useful information.
The Benefits of Effective Cost Control
Cost control enables a company to operate and thrive in a dynamic and competitive environment. A thriving company is not necessarily a fast-growing company but optimizes every aspect of its operations and generates healthy profits from its business model. The basic elements of cost control—good planning, careful monitoring of results compared with plans, and effective decision-making when variances arise—are common in successful companies. These companies don’t just control costs; they also continuously work on improving their plans and their operations.
The Future of Cost Management
Although the shape of the business world is changing, carefully managing and controlling costs is just as important as it ever was for keeping companies competitive and guaranteeing their long-term survival.
