Cost Control Concepts

The long-run prosperity of a firm depends upon its ability to earn sustained profits. Profit depends upon the difference between the selling price and the cost of production. Very often, the selling price is not within the control of a firm but many costs are under its control. The firm should therefore aim at doing whatever is done at the minimum cost. In fact, cost control is an essential element for the successful operation of a business. Cost control by management means a search for better and more economical ways of completing each operation. In effect, cost control would mean a reduction in the percentage of costs and, in turn, an increase in the percentage of profits. Naturally, cost control is and will continue to be of perpetual concern to the industry.

Cost Control Techniques

Cost control has two aspects such as a reduction in specific expenses and a more efficient use of every rupee spent. For example, if sales can be increased with the same amount of expenditure, say, on advertising and salesmen, the cost as a percentage of sales is cut down. In practice, cost control will ultimately be achieved by looking into both these aspects and it is impossible to assess the contribution, which each has made to the overall savings. Potential savings in individual businesses will, however, vary between wide extremes depending upon the levels of efficiency already achieved before cost controls are introduced.

It is useful to bear in mind the following rules covering cost control activities:

  • It is easier to keep costs down than it is to bring costs down.
  • The amount of effort put into cost control tends to increase when business is bad and decrease when business is good.
  • There is more profit in cost control when business is good than when business is bad. Therefore, one should not be slack when conditions are good.

Cost control helps a firm to improve its profitability and competitiveness. Profits may be drastically reduced despite a large and increasing sales volume in the absence of cost control. A big sales volume does not necessarily mean a big profit. On the other hand, it may create a false sense of prosperity while in reality; increasing costs are eating up profits. Profit is in danger, when good merchandising and cost control do not go hand in hand. Cost control may also help a firm in reducing its costs and thus reduce its prices. A reduction in prices of a firm would lead to an increase in its competitiveness. The aspect is of particular relevance to Indian conditions because of high costs, India is being priced out of the world markets.

Areas of Cost Control

Following are the areas where the cost can be controlled:

1. Materials

There area number of ways that help in reducing the cost of materials. If buying is done properly, a firm avails itself of quantity discounts. While buying from a particular source, in addition to the cost of materials, consideration should be given to freight charges. In some cases, lower prices of materials may be offset by higher freight to the firm’s warehouse. While buying, one may attempt to buy from the cheapest source by inviting bids. At times, it may be possible to have more economical substitutes for raw materials that the firm is using. Many a times, improvement in product design may lead to reduction in material usage. It is desirable to concentrate attention on the areas where saving potential is the highest.

Another area, which needs examination in this respect, is whether to make or buy components from outside source. Very often firm may find it advantageous to manufacture certain parts and components in one’s own factory rather than buying them. Yet in many cases there are specific advantages in purchasing spares and components from outside because suppliers may deliver goods at low cost with high quality. For example, Ford and Chrysler of the US Auto Industry purchase their components from outside source. But General Motors could not do so because the firm has its own departments for handling the process of production.

Continuous Research and Development (R&D) may also lead to a reduction in raw material costs. For example, General Motors have reduced the weight of their cars to make them more fuel-efficient. Better utilization of materials’may also save the cost of materials by avoiding wastes in storing, handling and processing. Some of the factors, responsible for excessive wastage of materials are: lack of laid down requirements for raw materials, bad process planning, rejects due to faulty materials or poor workmanship, lack of proper tools, jigs and fixtures, poor quality of materials, loose packing, careless and negligent handling and careless storage.

Exploration of the possibilities of the use of standardized parts and components and the utilization of waste and by-products, may also lead to a significant reduction in the cost of materials.

Inventory control is yet another area for reducing materials cost. Through inventory control, it is possible to maintain the investment in inventories at lowest amount consistent with the production and the sales requirements of firm. The cost of carrying inventories ranges from 15 to 20 per cent per annum account of interest on capital, insurance, storage and handling charges, spills breakage, physical deterioration, pilferage and obsolescence. Again 50 per cent the gross working capital may be locked up in inventories.

Some important ways of reducing inventories are:

  • Improved production planning.
  • Having dependable sources of supplies, which can ensure prompt deliver of materials at short notice.
  • Elimination of slow-moving stocks and dropping of obsolete items.
  • Improved flow of part and materials leading to increased machine utilization and shorter manufacturing cycles.

Packaging constitutes a significant proportion of raw materials (9 to 24 per cent) and of the total manufacturing expenses (7 to 22 per cent). Firm should make attempts to reduce the packaging costs to the minimum. The manufacturing firms such; cars and motor bikes may request its customers to return the containers in which are goods were sent so that they could be used in future. This is because packing of such goods as well as the materials used for packing is very expensive.

2. Labor

Reduction in wages for reducing labor costs is out of question. On the other hand, wages might have to be increased to provide incentives to workers. Yet there is good scope for reduction in the wage cost per unit. A reduction in labor costs is possible by proper selection and training, improvement in productivity and by automation, where possible. Work study might result in a lot of savings by reducing overtime and idle time and providing better workloads. Labor productivity might increase if frequent change of tools is avoided. Improvement in working conditions may reduce absenteeism and thus reduce costs per unit. Scrutiny of overtime may reveal substantial scope for savings.

All efforts must be made to reduce wastage of human effort. Wastage of human effort may be due to lack of co-ordination among various departments by having more workers than necessary, causes under-utilization of existing manpower, shortage of materials, improper scheduling, absenteeism, poor methods and poor morale. Attempts must be made to secure co-operation of employees in cost reduction by inviting suggestions from them. These suggestions should be carefully examined and implemented if found satisfactory. The basic idea is to motivate workers and make them perceive working in the firm as a participative endeavor.

3. Overheads

Factory overheads may be reduced by proper selection of equipment, effective utilization of space and equipment, proper maintenance of equipment and reduction in power cost, lighting cost, etc. For example, fluorescent lighting can reduce lighting cost. Faulty designs may lead to excessive use of materials or multiplicity of components, waste of steam, electricity, gas, lubricants, etc.

Taking advantage of truck or wagon-loads may reduce transportation cost. Careful planning of movements may also save transportation cost. Another point to be examined is whether it would be economical to use one’s own transport or hire a transport. For reasons of economy, many transport companies hire trucks rather than owning them. This is because purchase and maintenance of trucks can be more expensive. By chartering vehicles the problems of maintenance is left to the owner who in turn cuts cost for the firm. Thus by keeping a smaller work force on rolls and by introducing a contract rate linked to a safe delivery schedule it is possible to ensure speedy point-to-point delivery of goods. Many firms now prefer to use private taxis rather than have their own staff cars.

Reduction of wastes in general can also reduce manufacturing costs considerably. Of course, a certain amount of waste and spoilage is unavoidable because employees do make mistakes, machines do get out of order and sometimes raw materials are faulty. However, attempts can be made to reduce these mistakes and faulty handling to the minimum. The normal figure for the waste and spoilage depends upon the complexity of the product, the age of the manufacturing plant, and the skill and experience of the workers. Once normal wastage is found out, production reports must be watched carefully to find out whether the wastage’s are excessive. Wastes can be reduced considerably by educating operators in the causes and cures of the wastes. Bad debt losses can be reduced considerably by selecting customers carefully, and keeping an eye on the receivables. Concentrating on areas and media can reduce advertising costs, which give the best results.

Selling costs can be controlled by improving the supervision and training of salesmen, rearrangement of sales territories, replanting salesmen’s routes and calls and redirecting of the sales efforts, to achieve a more economic product mix. It may be possible to save selling costs by the use of warehouses, making bulk shipments to the warehouses and giving faster deliveries to the customers.

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