Controlling costs.

Introduction

This checklist is for managers (or owners of small businesses) who wish to address the issue of cost control.

In today's increasingly competitive business environment, getting the most from existing resources whilst ensuring costs do not escalate is one of the keys to business success or failure.

It is important to note, however, that controlling costs does not equate to cutting costs. Although there will always be occasions when a period of belt-tightening is required, frequent cost-cutting can have an adverse effect on the business--product quality may be affected so alienating customers, relationships with suppliers may be affected and staff may be demoralised. Inappropriate signals concerning the health of the business may also be made.

It is important to re-examine your costs and expenses regularly and recognise that it is easier to exercise control 'before' rather than correct 'after'. Keep financial reporting systems up-to-date and publish financial targets regularly and issue key statistics to managers and keep all staff informed.

Cost control can provide essential management information and effective cost control can help highlight inefficient practices.

National Occupational Standards for Management and Leadership

This checklist has relevance for the following standards: E: Using resources, unit 1.

Definition

A cost is the value of that which must be given up to acquire or achieve something.

Costs are the price paid for the acquisition, processing and delivery activities of turning raw materials into finished goods.

Costs may also be known as overheads or expenses--the term cost will be used throughout this checklist.

Action Checklist

1. Collect data on costs incurred

In order to implement cost control within an organisation, it is essential to collect data on what the costs actually are. Costs are often broadly categorised as labour costs, materials costs and general overheads. It is usually assumed that labour costs in service organisations are the greatest percentage of the total; in manufacturing however, figures are more likely to be: labour costs 15%, materials costs 50% and general overheads 30%.

2. Communicate cost awareness

Financial strategies must be communicated to, shared with and owned by all employees so that they understand the financial implications of their activities and decisions. It is important that employees are aware of the full costs of their activities as well as alternatives to them. For example telephone and stationery billing may be centralised, although true costing of all products and services should take account of this overhead on a departmental or activity basis.

Where the activities of cost centres are left unattributed, the level of service usage of such a centre should be considered in the cost allocation process.

3. Examine cost-allocation processes

The budget is the keenest instrument of cost control in any organisation. Drawing up and controlling a budget are covered in separate checklists. (See Related checklists). Budget control is a self-evident factor in cost control, but there are additional approaches and techniques which can support this process.

One method of discovering true costs is to re-start the budgeting process from scratch and attempt to estimate--as if there were a blank sheet of paper--the full costs of an activity. This is called zero-based budgeting, and works on the basis that annual budget allocations should be justified from the ground upwards. Discovering full cost allocation in this way may well prompt the question: "Is this activity necessary in the first place?" Remember fixed costs. If you take an activity out, then an element of fixed cost will be re-allocated to the remaining activities.

Activity-based costing (ABC) involves looking closely at those key factors that influence an organisation's overheads and attempts to work out what constitute the key cost factors. ABC requires that all costs associated with a product--from research and new product development to marketing and delivery--should be identified as product costs, or split up and traced to individual products or services.

Costs are often difficult to isolate because they are made up of multiple tasks and activities which may appear unrelated in the structure of the organisation. For example, we receive a service from another section or department, and are aware of its value to us, but unaware of the cost attached to its supply. One method of tackling this is Overhead Value Analysis, which attempts to trace and quantify the workflows--increasingly these are information workflows--which take place in the supply of services to other parts of the organisation.

4. Identify the various cost elements

Costs are either fixed, such as buildings, or variable, such as raw materials. Some costs fall in between; these are known as semi-variable.

Major cost elements include:

* space, rental, local business tax

* energy costs, such as heating and lighting, as well as the costs of waste, disposal and possible pollution. Is there an environmental policy in force?

* costs including salaries and wages--and not forgetting the costs of recruitment, absenteeism, sick pay, pensions and insurance

* raw materials and services bought in

* travel and transport--have new telecommunications technologies been considered?

* general costs of communication--postage, telephone, fax, stationery and supplies--email as an alternative?

* security and insurance--without turning a disaster into a crisis, can you be without them? Are there preferable services rates worth investigating? Is there a disaster recovery plan?

* costs of borrowing, of allowing credit, and of bad debts.

5. Monitor variable costs

Variable costs are normally tied to sales volume. They may include:

* salaries and wages

* advertising costs

* selling expenses

* mailing expenses

* stationery supplies

* subscriptions

* heat, light, power and water.

What is the continuing relationship between sales volume and costs? Is the trend healthy or unhealthy, positive or negative?

6. Examine your costs and expenses regularly

Recognise that effective control can help you to increase your profits on the same or even a reduced volume of sales--or of turnover. Keep the pattern of your sales volume over time as closely under observation as your costs. Know the reasons for abnormal increases or decreases.

Calculate regularly the costs of goods sold as a percentage of net sales. Look for increases or decreases in the price of purchased items, increased transport costs, wastage, or losses due to theft.

Do not let your fixed costs blindly follow increases in sales volume which may not be repeated.

7. Be aware of how cost control affects other components of profitability Remember that costs are only one member of the family of factors which together influence profitability. The others are:

* sales volume/value

* net margins

* capital employed 

* product mix.

A change in any one affects each of the others, favourably or unfavourably. If cost control leads to a change in costs, then be mindful of the likely impact on sales volume, net margins, capital employed, and product mix. You cannot always have your cake and eat it.

8. Remember quality

Remember the primacy of the customer, whose own personal loyalty is to the best quality at the lowest price. Buying in the cheapest raw materials is not usually the best solution, as cheaper often means worse not better.

Schemes such as TQM, ISO9000 and continuous improvement programmes to improve quality in organisations bear evidence of capability to reduce costs through systematic removal of waste and duplication, largely by empowering the workforce and pushing decisions down to where the work is actually done.

How not to manage the control of costs

Don't:

Forget that staff may have useful views on controllable costs, nor overlook the fact that cost control may have an impact on staff morale which may be good or bad.

Additional resources

Books

Cost reduction and control best practices: the best ways for a financial manager to save money Hoboken NJ: John Wiley, 2006

The cost management toolbox: a managers guide to controlling costs and boosting profits Lianabel Oliver New York NY: AMACOM, 2000

A practical foundation in costing David Wright London: Routledge, 1994

This is a selection of books available for loan to members from the Management Information Centre. More information at: www.managers.org.uk/mic