What is Cost Control?
Cost control is the practice of identifying and reducing business expenses to increase profits, initiated through the budgeting process. A business owner reviews the company’s actual financial performance against budgeted projections. If actual costs exceed planned costs, management can take necessary corrective actions.
For instance, a company can solicit bids from varying vendors offering the same products or services to reduce costs. Effective cost control is vital for maintaining and growing profitability.
Outsourcing corporate payroll, for example, can be cost-effective, particularly since payroll tax laws frequently change, and employee turnover leads to regular updates in payroll records. A payroll company can handle net pay calculations and tax withholdings, saving the employer both time and expenses.
Key Takeaways
- Cost control involves identifying and reducing expenses to increase profitability, initiated through budgeting.
- It is crucial for sustaining and improving profitability.
- Outsourcing can be an effective cost-saving strategy, as third-party services can be more economical than in-house operations.
Understanding Cost Controls
Cost control plays a critical role in planning for desired net income, computed using the formula:
Sales - fixed costs - variable costs = target net income
For example, consider a retail clothing store aiming to earn $10,000 in net income from $100,000 in sales monthly. Management must evaluate both fixed and variable costs, seeking to reduce expenses. Inventory, a variable cost, can be minimized by sourcing from more cost-efficient suppliers.
Fixed costs like lease payments might require more time to reduce because they are often bound by contracts. For public companies, achieving targeted net income is particularly important because investors expect consistent earnings growth.
Cost Control and Variance Analysis at Work
A variance represents the difference between budgeted and actual results. Managers use variance analysis to spotlight critical areas requiring change. Companies should perform monthly variance analysis on every revenue and expense account. Prioritize addressing the highest-dollar variances as they most significantly impact results.
For instance, if a toy manufacturer faces a $50,000 unfavorable variance in material costs, the company could seek competitive bids from other suppliers to reduce future discrepancies. Some companies focus on variances with the largest percentage differences from their budgets.
Why Is Cost Control Important for Businesses?
In competitive markets, low-cost producers achieve higher profits. Reducing costs boosts both efficiency and profitability, making cost control a core objective for businesses.
Types of Business Costs
Business costs are generally categorized into fixed vs. variable and direct vs. indirect costs.
- Fixed Costs: Costs that remain unchanged, such as rent or insurance.
- Variable Costs: Costs that vary with productivity, like wage labor or energy consumption.
- Direct Costs: Costs directly involved in production or operations, such as raw materials.
- Indirect Costs: Overheads and costs not directly linked to core operations.
How Can Households Implement Cost Controls?
Cost control isn’t limited to businesses; households benefit by increasing savings and cash flow. Key strategies include disciplined budgeting and competitive shopping. Look for sales and consider second-hand goods to minimize expenses.
Related Terms: capital budgeting, payroll, public company, process value analysis, fixed costs, variable costs, direct costs, overhead.
