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Oct 1994

Six steps to effective cost management. (CPA In Industry)

by Godey, Jim

    Abstract- Reckless, short-sighted cost-cutting will not necessarily benefit a company and quite often can have a negative impact in the medium or long-term. What is needed is cost management, which differs from cost control in that it is aproactive process that focuses on the elimination of waste in business processes and procedures. Cost management, as such, is a strategic process that stresses the optimization of efficiency. Among others, this approach requires strong leadership skills, since managers need to improve customer satisfaction while boosting profitability. Six steps to effective cost management are provided. These are understanding the cost-revenue structure of a business, minimizing interdepartmental conflicts, involving workers in decision making, increasing effectiveness, and measuring cost judgments against a long-term strategic plan.

But cost cutting is not always the answer. Cost cutting will usually fail to produce long-term results and will likely harm the company. Cost cutting is short sighted and random and is not based on the company's business strategy. It is usually a reaction to immediate problems and not well thought out. While cutting costs will appease a short-term need, the process will have to be repeated in the near future because the real problems were not solved, only the symptoms were dealt with.

What companies really need to be doing is managing their costs. Managing costs does not focus on cost cutting, it entails waste elimination. When companies cut costs, they wind up hindering their development and growth. Managing costs focuses on eliminating unnecessary expenditures (waste) while focusing resources on the customers. It is estimated that most companies are wasting about 30% of their expenditures on items that do not have any impact upon their customers.

Cost Management Steps

The managing of a company's cost structure is consciously choosing to invest in selected expenditures that will achieve a specific revenue system. This is a proactive process, whereas cost cutting is a reactive process. Managing costs is inherently more effective. This effectiveness involves doing the things that optimize the results of a company's overall activities. Reactive cost cutting may add some efficiency, but it does not optimize the company's business process or its results.

Cost management is a strategic process that focuses on the customer and on profitability. The six steps to effective cost management are:

* Understand what causes the cost and revenue structure of the business

* Understand and reduce interfunctional complexity

* Provide the tools to manage costs

* Involve employees in decisions

* Increase effectiveness and continuously improve costs

* Measure decisions against the strategic business plan

Understand What Causes the Cost and Revenue Structure of the Business. This is the most critical item in cost management. Many companies do not have accurate information on what their true costs are. A company must first identify exactly where its revenue comes from--products, services, customers, and sales channels. Next, a company must identify the specific costs that produce its revenue stream. Finally, a company must identify overhead costs and costs not directly linked to revenue generation. Salesmen's commissions can easily be linked to revenue, but this link is not as direct for office supplies. Nevertheless, office supplies are needed somewhere during the sales process.

Understand and Reduce Interfunctional Complexity. In any organization, the way any one department operates is influenced by other parts of the company. For example, marketing has an influence on inventory levels, which effect warehousing and transportation costs. The complex cause- and-effect relationships must be sorted out. Reducing complexity means constantly questioning why work is done, and how it can be done more efficiently. A basic flow chart of the company's work flow can be very helpful in understanding how things actually get done. It will probably also show that there are a number of extra, unnecessary steps involved in the company's processes. Look for ways to get the right information to those who need it as quickly as possible. The sales department needs to know what products are not selling--daily, not just at the end of the month. The production people need to know what products are selling so that they can produce what is wanted by the customers. In many companies, the production people get this information once a month-- enough time to have wasted a month producing the wrong products.

Providing the Tools to Manage Costs. Provide the skills (i.e. decision- making, problem-solving, team-building, and other thinking skills) that will enable employees to better understand how to control costs, improve quality and productivity, and enhance performance. Most people want to do a good job. When a company invests in their employees by educating them, the employees will be better able to do a good job.

Involve Employees in Decisions. Employees will need to understand the company's objectives and have accurate cost information. Soliciting input from the employees will not only give management a better understanding, but it will give employees more incentive to become involved. Companies that actively solicit suggestions from their employees will undoubtedly find better and more cost effective ways to do things. When someone works with it everyday, they will have insight into the work and possibly how to do it better. Ask employees how they would do it better.

Increase Effectiveness and Continuously Improve Costs. Redefine the company's cost structure to select the costs that generate profit. Cost management must become standard operating procedure. Management and employees must be constantly identifying opportunities for eliminating or reducing unprofitable work. When a company only incurs costs that are specifically linked (with reasonable overhead) to revenues, they will be maximizing their profitability. A company may need to eliminate departments, or it may need to consolidate or even expand departments based upon where their spending generates revenue.

Measure Decisions Against the Strategic Business Plan. Every company needs to have a long-term business strategy. Cost management should be part of the strategy and be influenced by the strategy. Cost decisions should be measured against the company's strategy, rather than a current short-term situation. A company should not buy an excessive amount of inventory because the manufacturer has lowered the price to get rid of it. The company should be buying the amount it needs to satisfy its customers.

Controlling costs through short-term cost cutting leads a company to unprofitability. Cost management will ensure long-term growth and profitability.

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