What is Cost Control in Business? Benefits, Process, and More
Creating a company budget can be one of the most challenging business tasks to undertake. Financial advisors are responsible for breaking down departments, operations, and jobs to determine precisely how much money and resources are needed.
Underestimating budgets can result in incomplete projects, which can waste valuable time and disrupt sequential systems. On the other hand, overestimating budgets can occupy funds that can be used elsewhere.
With cost control, businesses can continuously monitor and adjust their budgeting tactics to reduce expenses and improve accuracy.
What is Cost Control?
Cost control is the process of defining and minimizing business expenses to boost profits and the bottom line. Starting with budgeting, owners compare their organization's actual financial health with their budget expectations.
If the actual costs are higher than the projections, management needs to exercise their cost control to reduce expenses. For example, companies can negotiate contracts with suppliers to lower the cost of raw materials and shipping.
Cost control and cost management are often used interchangeably but actually handle two different financial elements. Although both are necessary to improve profitability and business growth, cost management involves the logistics pertaining to budget preparation. From initial planning to funding, cost management considers the full life cycle and the resources needed for a financial project.
On the other hand, cost control is more concerned with measuring the difference between the cost baseline and budget and developing corrective action. Various procedures and tools, such as analytics software, are often implemented to monitor expenditures and real-time financial health. Data collected from these metrics are used to forecast future costs.
When businesses sharpen their cost control skills, they can influence their cash flow and profits. It also enables management to streamline and actively monitor financial workflow.
In order to maintain cost control, companies need to be aware of-
- What needs to be done - By tracking budgets and profiles, management can outline what activities need to be performed to lower expenses.
- What has already been done - Scheduled reports should show performance data on the active budget and tasks.
- How actual and expected performances compare - Comparing the actual and ideal expenses gives businesses an accurate insight into their financial planning and control.
- What corrective actions should be implemented - Based on the comparison, management must develop a plan of corrective action to narrow the gap between the expected and actual budget.
- Alterations to the plan of action - By closely monitoring the corrective actions, managers can determine whether they need to implement any plan changes.
Benefits of Cost Control
Aside from the obvious benefit of saving money, companies that practice cost control can increase their efficiency through-
- Debt Management
By reducing expenses, businesses can lower their debt and increase their overall value. Capital saved by minimizing costs can then be put towards savings or investments.
Without cost control, organizations can quickly accumulate debt due to poor financial management and potentially go out of business.
- Increased Budgets
Most businesses push extra funding towards their marketing and advertising sectors, as they typically show the highest return on investment (ROI) through increased traffic and sales. However, this is only effective for companies that already have an established clientele and product line.
For example, a retailer that has already pinpointed their demographic and modeled their buyer persona can invest in a targeted marketing campaign to guarantee increased exposure. Any leftover funds can be used to grow the sales team or even develop additional promotions.
- Better Credit
Although it may be difficult to immediately reduce debt accrued from large assets, such as equipment and property, organizations should consider minimizing ongoing expenses, such as operating costs.
By eliminating small expenditures here and there, businesses can boost their credit ratings and secure loans that they can use to invest in essential assets, including inventory and facilities. These investments promote company expansion, enabling businesses to better manage their expenses once they increase their income.
- Enhanced Competitive Advantage
- Improved Morale
Research shows that employees are more likely to work hard when their performance is recognized and rewarded. By expanding the business, workers have the opportunity to get promoted and climb the ladder.
- More Qualified Employees
This is very useful when trying to fulfill higher positions, such as managers, directors, and coordinators. Onboarding skilled employees boosts the business's value and overall employee roster.
4 Measures of Cost Control
Even with a sophisticated finance department, it can be challenging to determine where to cut funding. However, cost control is necessary to promote profitability and operational efficiency.
Therefore, companies should consider utilizing these four cost control strategies to minimize overhead expenses-
1. Hire the Best Workers
From scouting applicants to the onboarding process, careful hiring is a crucial element in cost control. Bad hires can waste funds, lag systems, and significantly impact productivity.
In fact, studies show that managers spend over 10 hours a week training underperforming workers. This is valuable time that could be used to complete more pressing tasks.
Unsuitable hires can also negatively affect company morale and harmony. Therefore, companies should carefully invest their hiring budget to ensure employees are qualified and mesh well with the existing team.
2. Negotiate Agreements
Most modern businesses work with several third-party vendors rather than relying on a sole supplier. This gives the company leverage when negotiating annual contracts, which can lead to significant cost savings.
Long-term contracts that span over a few years typically favor the supplier. By opening the contract to yearly bidding, businesses can potentially lower the cost of goods. Companies can also opt for an annual rate renegotiation, where both parties get the chance to settle a new agreement at the end of the year.
3. Build Stable Relationships with Vendors
While negotiation is a crucial element to cost control, businesses need to keep their vendors happy. This means companies should prioritize building strong, symbiotic partnerships with their suppliers to keep all parties satisfied.
Frequent late payments and other inconveniences not only accrue additional expenses, but they also damage supplier relationships. Instead, companies should make a conscious effort to pay invoices as soon as possible and even reward suppliers that exceed expectations with more business offers.
Ensuring all payments are on time gives businesses even more leverage when negotiating contracts, especially if the vendor's other clients are not as considerate.
4. Utilize Cloud-Computing Management Systems
Modern technology enables businesses to simultaneously store data and access software to streamline standard tasks. Cloud-computing management systems, such as accounting software, enhances data sharing and communication between departments to improve efficiency.
Cloud-based systems are active around the clock and automate repetitive tasks, such as record keeping, which can reduce labor expenses. This gives companies more flexibility when it comes to designating employees for various jobs.
4 Steps for Cost Management
Although cost management is a continual process, management can break it down into four sequential stages. This allows organizations to evaluate their plans in between the steps to make any adjustments.
The four steps for cost management are-
1. Resource Planning
Resource planning is the task of discovering the resources needed to complete a project. For businesses, resources can include labor, equipment, raw materials, inventory, and facilities.
Resource planning must be finished before beginning a project to prevent disruptions that could occur due to insufficient materials.
First, project managers need to create a work breakdown structure (WBS), which isolates each stage of the operation, making it easier to identify what resources are required. If managers are unfamiliar with some of the tasks, they can ask experienced employees for input.
Managers should make a detailed list of all of the resources that need to be sourced, along with the deadlines. To streamline this step, management should consider-
- Referencing historical data, such as past schedules and finance reports.
- Requesting feedback from team members when no historical data is available.
- Evaluating time-sensitive materials and their impact on the overall project.
- Outsourcing a third-party with expertise in the operation.
2. Cost Estimation
Cost estimation is the process of calculating the cost of all the resources needed for the project. In order to do this, management needs information on-
- Resource requirements
- Material prices
- How long each resource is needed
- List of assumptions
- Potential risks
- Previous project costs and any relevant benchmarks
- Company's expense reports and financial standing
This is typically the most challenging step as it requires managers to calculate the most accurate estimate to perform the next steps. There are also many elements to consider, such as fixed, variable, overhead, and inflation costs, some of which can change over the course of the project.
The greater the difference between the actual and estimated costs, the more likely the project will fail. Therefore, managers should consider using estimation models to better forecast expenses.
The analogous estimation model uses historical data and trends to predict costs for similar projects, making it ideal for businesses that keep documentation for long periods. Companies can also use the parametric modeling or program evaluation and review technique (PERT), which takes a more mathematical approach.
3. Cost Budgeting
Cost budgeting is sometimes grouped with cost estimation but requires enough labor to be considered its own task. Budgeting is the process of designating funds to different projects, operations, and departments for a specific timeframe. Budgets should include contingency reserves in case unexpected expenses occur.
By establishing a budget, businesses can create an expense baseline to measure their cost performance against. This enables management to quantify the difference between actual and estimated costs instead of referencing an abstract metric.
An accurate budget allows companies to forecast future cash flow and improve budget strategies. Once the fiscal year is over, financial advisors can evaluate expenses to determine if there are any leftover funds and discuss how they can firm up the budget for the following year.
4. Cost Control
Cost control measures the expense variances from the baseline to formulate appropriate corrective action. This can include expanding the budget or minimizing the project to narrow the gap.
Aside from the expense baseline, management must determine how they will measure the company's financial performance, along with any deviations.
Many companies use the earned value management (EVM) approach to measure cost performance. This method compares how much of the assigned funding is used at any given time to the overall budget.
For example, if a four-week project is remaining under budget going into week three, managers can forecast that they will have leftover funds. However, if managers report that the expected weekly budget is not covering actual expenses, they will have to regroup and pinpoint the variances.
With effective cost control, businesses can take a proactive approach on meeting financial obligations to reduce expenses and boost profits.
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