Techniques of Cost Control
Following are the techniques/tools that are used for the cost control.
1. Standard Costs and Budgets
The technique of standard costing has been developed to establish standards of performance for producing goods and services. These standards serve “as a goal for the attainment and as basis of comparison with actual costs in checking performance”. The analysis of variance between actual and standard costs will: (i) help fix the responsibility for non-standard performance and (ii) focus attention on areas in which cost improvement should be sought by pinpointing the source of loss and inefficiency. The principle here is that or controlling by exception. Instead of attempting to follow a mass of cost data, the attention of those responsible for cost control is concentrated on significant variances from the standard. If effective action is to be taken, the cause and responsibility of a variance, as well as its amount, must be established.
The prime objective of standard costs is to generate greater cost consciousness and help in cost control by directing attention to specific areas where action is needed. To those who are immediately concerned, variances would indicate whether any action is required on their part. It must be noted that
- Costs are controlled at the points where they are incurred and at the time of occurrence of events, and
- At the same time they may be uncontrolled at some points.
It is, therefore, necessary to understand the difference between controllable and uncontrollable costs. The variances may also be controllable and uncontrollable. For example, if the material cost variance is due to rise in prices, it is not within the control of the production manager. But if the variance is due to greater usage, control action is certainly possible on his part. The higher management can also decide whether or not they should intervene in the matter. Sometimes, variances may be so significant that a complete reappraisal of the standard costs themselves may be needed.
For example, if the variances are always favorable it may point to the fact that the standards have not been properly fixed. Standard costing can also provide the means for actual and standard cost comparison by type of expense, by departments or cost centers Yields and spoilage can be compared with the standard allowance for loss. Labor operations and overheads also can be checked for efficiency.
Flexible budgets constitute yet another effective technique of cost control, especially control of factory overheads. Flexible budgets, also known as variable budgets; provide a basis for determining costs that are anticipated at various levels of activity. It provides a flexible standard for comparing the costs of an actual volume of activity with the cost that should be or should have been. The variances can then be analysed and necessary action can be taken in the matter.
The scientific establishment of standards of performance through standard costs and budgets has not only provided better cost control but has led to cost reduction in a number of companies. This has been the case especially in companies where standards were tied to wage-incentive plans and improvement in control is part of a general programme of better management.
2. Ratio Analysis
Ratio is a statistical yardstick that provides a measure of the relationship between two figures. This relationship may be expressed as a rate (costs per dollar of sales), as a per cent (cost of sales as a percentage of sales), or as a quotient (sales as a certain number of time the inventory). Ratios are commonly used in the analysis of operations because the use of absolute figures might be misleading. Ratios provide standards of comparison for appraising the performance of a business firm. They can be used for cost control purposes in two ways:
- A businessman may compare his firm’s ratios for the period under scrutiny with similar ratios of the previous periods. Such a comparison would help him identify areas that need his attention.
- The businessman can compare his ratios with the standard ratios in his industry Standard ratios are averages of the results achieved by thousands, of firms in the same line of business.
If these comparisons reveal any significant differences, the management call analyse the reasons for these differences and can take appropriate action to remove the causes responsible for increase in costs. Some of the most commonly used ratios for cost comparisons are given below:
- Net profits/sales.
- Gross profits/sales.
- Net profits/total assets.
- Sales/total assets.
- Production costs/costs of sales.
- Selling costs/costs of sales.
- Administration costs/costs of sales.
- Sales/inventory or inventory turnover.
- Material costs/production costs.
- Labor costs/production costs.
- Overhead/production costs.
3. Value Analysis
Value analysis is an approach to cost saving that deals with product design. Here, before making or buying any equipment or materials, a study is made of the purpose to which these things serve. Would other lower-cost designs work as well? Could another less costly item fill the need? Will less expensive material, do the job? Can scrap be reduced by changing the design or the type of raw material? Are the seller’s costs as low as they ought to be?. Suppliers of alternative materials can provide the ample data to make the appropriate choice. Of course, absorbing and reviewing the data will need some time. Thus the objective of value analysis is the identification of such costs in a product that do not in any manner contribute to its specifications or functional value. Hence, value analysis is the process of reducing the cost of the prescribed function without sacrificing the required standard of performance. The emphasis is, first, on identification of the required function and, secondly, on determination of the best way to perform it at a lower cost. This novel method of cost reduction is not yet seriously exploited, in our country. Value analysis is a supplementary device in addition to the conventional cost reduction methods.
Value analysis is closely related to value engineering, though they are not identical. Value analysis refers to the work that purchasing department does in-this direction whereas value engineering usually refers to what engineers are doing in this area. The purchasing department raises questions and consults the engineering department and even the vendor company’s department. Value analysis thus requires wholehearted co-operation of not only the firm’s expertise in design, purchase, production and costing but also that of the vendor and other company expertise, if necessary. Some examples of savings through value analysis are given below:
- Discarding tailored products where standard components can do.
- Dispensing with facilities not specified or not required by the customer, for example, doing away with headphone in a radio set.
- Use of newly developed, better and cheaper materials in place of traditional materials.
Cost control is applicable only to such costs, which can be altered by the management on their own initiative. It may be noted in this context that, by and large, non-controllable costs exceed far more than controllable ones thereby restricting the scope of profit improvement through cost control. Of course, attempts may be made to convert an uncontrollable cost into a controllable one. Vertical combinations to secure control over sources of supply provide an example. So also instead of buying a component, a firm may decide to make the conversion possible.
External Links about Cost Control:
- Cost Control and Reduction (Inc.)