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What Is Cost Management?
Cost is an amount that has to be paid or spent to buy or obtain something. Managing cost or cost management means to adjust certain conditions that cause an increase or decrease in cost. In production, research, retail and Accounting a cost is the value of money that has been used up to produce something or deliver a service and hence is not available for use anymore.
In business, the cost may be acquired, which means the cost of money spent on acquiring something. In accounting, cost is defined as the cash amount or cash equivalent given up for an asset.
All these definitions of cost have been given because no matter the variations, they are still similar and also apply in every part of a business. In business, cost has become the most important factor, the information on cost can greatly affect the existence of the business. Cost is a major determinant in business activities and operations.
Before setting up a business, you must ascertain the start-up cost and the cost of running the business operations. Cost information is one of the most important information any business entity should pay very close attention to.
Having considered what cost is, managing cost is key in any business decision and it makes a substantial part of strategic planning and decision making. Cost management focuses on cost reduction and continuous improvement and change rather than cost containment. Cost management consist of those actions that are taken by managers to reduce cost, some of which are prioritised on the basis of information extracted from the accounting system.
It is important that you know all the approaches that can be used to reduce cost even if these methods do not rely on the accounting information. You should also note that, although cost management seeks to reduce cost, it should not be at the expense of customer satisfaction. Ideally, the aim is to take action that will both reduce costs and enhance customer satisfaction.
Ways to effective cost management
To properly manage cost, we have to first identify cost objects and cost centre. Also, cost estimation should be done with the utmost expertise so that the actual cost will be generated and properly allotted to the cost centres and cost objects from which they were incurred.
The way cost is allocated, should be done with great skill, traditional or arbitrary style should be avoided, rather Activity-Based Costing(ABC) should be used, so overheads can be properly allotted.
Here are some good practises towards managing cost in order to increase profit.
1. IDENTIFY COST OBJECTS AND COST CENTRES
Cost objects are activities for which separate measurement of cost is desired e.g cost of products, cost of service, cost of operating a particular department or sales territory, while cost centres are described as locations where overhead cost are initially assigned, they consist of departments in an organisation like sales, marketing and the likes. Once these have been identified, you can objectively sort out ways of reducing such costs.
2. PROPER ALLOCATION OF COST
Since you have been able to identify the cost objects and centres, cost should be properly assigned to where there were incurred. If we say the sales department generated the most cost, such should be identified and properly assigned to the sales department rather than spreading it to other departments which did not contribute to the cost. Once the cost has been properly assigned and allotted, it can thereon be worked on and reduced in order to increase profitability.
3. MAINTAIN A PROPER COST MANAGEMENT DATABASE
A database of all the cost of the business should be maintained, with cost appropriately coded and classified, so that relevant cost information can be extracted to meet each requirement. A suitable coding system enables cost accumulated by the required cost objects(such as product or service, departments, distribution channels, etc) and also to be classified by appropriate categories.
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Typical cost classification within the database such as (direct material, direct labour and overhead) and by cost behaviour (fixed and variable). Maintaining a cost database is key because it could be used for future decision making. In addition, the database should be reviewed and updated at periodic intervals and kept up to date.
4. COST REDUCTION TECHNIQUES SHOULD BE IDENTIFIED
There are certain workable techniques that can be applied to properly reduce cost. These techniques identify how cost is incurred, it shows what could be reduced and how best to reduce it, in order to arrive at the least cost possible without compromising quality. Some of the techniques that can be used are;
A. LIFE CYCLE COSTING, it estimates the cost of a product over its entire life cycle from introduction to exit from the market, in order to determine whether the profit earned during manufacturing phase will cover the cost incurred during the pre and post-manufacturing stages.
B. TARGET COSTING; this includes determining the target price which customers will be willing to pay for the product, deduct a profit margin from the target price to determine the target cost, estimate the actual cost of the product and if actual cost exceeds the target cost, investigate ways of driving down the actual cost to the target cost.
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C. TEAR-DOWN ANALYSIS; Involves examining a competitor’s product in order to identify opportunities for product improvement and /or cost reduction. The competitor’s product is dismantled to identify its functionality and design and to provide insight into the processes that are used and the cost to make the product. The aim is to benchmark provisional product design with the design of competitors’ and to incorporate any observed relative advantages of the competitor’s approach to product design.
D. VALUE RE-ENGINEERING; Is an examination of the factors affecting the cost of a product or service in order to devise means of achieving the specified purpose at the required standard of quality and reliability at the target cost. The essence of value re-engineering is to achieve the assigned target cost by, identifying improved product designs that reduce product’s cost without sacrificing functionality and or eliminating unnecessary functions that increase the product’s cost and for which customers are not prepared to pay extra.
In conclusion, when managing cost we should have in mind that cost can never be eliminated totally but if properly managed, the certain cost could be avoided, also cost details should be given huge attention because, cost determines profit and prices, so cost should be given proper credence in the analysis. Expertise should be used so as to get the required benefits. Certain cost procedures might seem costly to operate but in the long run, it saves a lot of Costs too. Also, a very detailed database of cost should be maintained, updated and reviewed so it can provide necessary information when needed for the particular purpose. Finally, cost should not be reduced to the point where quality is now compromised, because customers want the best quality at the cheapest price possible.