Avoidable Cost

Updated on April 9, 2024
Article byWallstreetmojo Team
Reviewed byDheeraj Vaidya, CFA, FRM

Avoidable Cost Meaning

Avoidable cost is a business cost incurred by a firm that does not serve a purpose. It can be removed, ceasing to conduct the specified commercial activity. The main aim of this cost is to alert the firm about an unnecessary cost that a firm could avoid. 

Avoidable Cost

You are free to use this image on your website, templates, etc, Please provide us with an attribution linkHow to Provide Attribution?Article Link to be Hyperlinked
For eg:
Source: Avoidable Cost (wallstreetmojo.com)

These costs help the company in developing better cost strategies. It serves as a tool for reviewing the cost structure. In addition, firms can easily identify irrelevant costs. As a result, there are efficiency and cost-savings. Besides, it also enhances the risk management of the firm. However, ignoring them can bring losses for the firm. 

Key Takeaways

  • Avoidable costs are unwanted and unnecessary business expenses they can avoid before it takes place. In addition, it helps to eliminate costs that can increase the budget.
  • It is useful in the short term for eliminating raw materials, unwanted labor wages, cost of goods sold (COGS), and others. 
  • These costs can be either fixed or variable, but most are variable. As a result, they can affect the level of production output. 
  • The formula of avoidable expenses are total cost less sunk costs (Avoidable cost = Total Cost – Sunk Cost). 

Avoidable Cost Explained

Avoidable costs allow businesses to identify certain costs or expenses that are useless. Thus, they can choose to avoid them rather than incur them. Avoidable cost for firms are either fixed or variable, but most of them are variable. Moreover, companies refer to them as escapable costs. 

The concept of avoidable cost for the firm is very relevant to modern finances. Many expenses have equal importance in the budget prepared, like fixed and variable costs. Thus, the avoidable cost of a firm can be both. For example, fixed costs include salaries, electricity, taxes, rent, and others. In contrast, variable costs include raw materials, cost of goods sold (COGS), wages, and others. However, firms can ignore some expenses that serve no purpose. They must perform and prepare a cost strategy that helps identify unwanted expenses. Once analyzed, companies can take certain steps to avoid them. 

It takes time to prevent variable expenses completely. For example, the business may still have agreements with employees for direct labor or suppliers for direct materials. The business will be able to stop paying the charges once these agreements are over.

Financial Modeling & Valuation Courses Bundle (25+ Hours Video Series)

–>> If you want to learn Financial Modeling & Valuation professionally , then do check this ​Financial Modeling & Valuation Course Bundle​ (25+ hours of video tutorials with step by step McDonald’s Financial Model). Unlock the art of financial modeling and valuation with a comprehensive course covering McDonald’s forecast methodologies, advanced valuation techniques, and financial statements.

Strategy 

It is often possible to avoid escaping costs by eliminating unnecessary expenses. However, to identify them, firms use a strong cost strategy. It helps large corporations analyze these costs for a financially sound cost structure. As a result, it improves and enhances the profitability and efficiency of the firm. Yet, paying attention to these costs can increase budget and losses. 

A cost strategy where most costs are preventable is beneficial for all businesses. Businesses frequently need to analyze their expenditures to find ways to shift inescapable expenses to avoidable expenses.

The advantage is that a corporation can quickly adapt and maneuver during economic downturns or times of financial difficulty by cutting unnecessary costs. To achieve it, it might be necessary to streamline product categories, increase productivity, or bargain for shorter-term building leases or supplier contracts.

Avoidable Cost Formula

Let us look at the average avoidable cost formula for a better understanding:

Avoidable cost = Total Cost – Sunk Cost 

Where total cost is the total amount of expenses incurred by the firm; thus, it includes both fixed and variable overheads. And the sunk cost is a type of cost a firm cannot recover under any circumstances. For example, marketing expenses, salaries, new software installation, and others. 

A firm must follow certain steps along with the formula to calculate the average avoidable cost. Let us look at them:

  • First, calculate the total cost for the firm. It includes fixed and variable costs.
  • Determine whether a firm has incurred sunk costs it cannot recover. For example, salaries of the employees, marketing, or advertising expenses.
  • Use the above formula, and calculate it.

These costs are mostly variable as a firm can decide about its utility. For example, if a business feels a laborer is not producing enough output, they can remove him and save on wages. Since the firm had the flexibility and did not feel compelled to retain that employee, the wages were avoidable. 

Examples

Let us look at the examples of the avoidable cost to comprehend the concept better:

Example #1

Suppose Alex owns a bakery business in Ohio, the United States. Every week, he incurs various expenses that can be important or reverse. Thus, they noticed some new costs at the month’s end while preparing the ledger. For example, it could have reduced the cost of ingredients supplied by a bakery’s supplier. As a result, Alex changed the supplier and eliminated avoidable expenses. Likewise, Alex switched from power-consuming to power-saving bulbs. However, if they had not analyzed the unnecessary costs, it could have increased the losses for the firm. 

Example #2

In October 2022, industry experts in the United Kingdom requested the new Prime Minister, Rishi Sunak, to drop the unnecessary costs. The chief executive of the Food and Drink Federation, Karen Betts, stated that the food industry hopes the new prime minister to impose red tape and remove avoidable costs. 

Avoidable Cost And Unavoidable Cost 

Although avoidable and unavoidable expenses sound antonymous, they differ slightly. While a firm can avoid the former easily, the reverse is for the latter. If businesses feel costs are not serving any purpose or are useless, they can eliminate them. Therefore, they are important in the short term. Unavoidable expenses are necessary, thus, vital in the long term. In contrast, the former affects the output levels while the latter does not. 

BasisAvoidable Cost Unavoidable Cost
MeaningType of costs that a firm can avoid as they are yet to take place.Unavoidable costs are expenses that a firm cannot avoid despite its disadvantage.
PurposeTo eliminate unwanted costs.To retain them as they are useful in the long term.
DurationUseful in the short term.Suitable for long term.
ImpactsAffects the level of output.Does not affect it.
SubdivisionsFixed and variable costs, but mostly variable costs.Sunk costs fall into these costs.
Also known asEscapable costs, controllable costs.Inescapable costs, uncontrollable costs.

Frequently Asked Questions (FAQs)

1. Are avoidable costs relevant?

Avoidable expenses are relevant for elimination as they are unnecessary. For example, if a firm finds that a laborer is not efficient enough and finds it relevant to eliminate, it can do so. 

2. How to identify an avoidable cost?

An individual or business owner can analyze unwanted expenses to identify avoidable expenses. Or else they are irrelevant to the company. Next, prepare a list of such expenses and find alternatives to replace them.

3. What is the synonym for avoidable cost?

The synonyms for avoidable costs are escapable costs or controllable costs. 

4. Why is a relevant cost called an avoidable cost?

Although avoidable and relevant costs have the same definition, they differ hugely. For example, relevant costs is a term related to managerial accounting, whereas avoidable expenses are more concerned with a business concept or cost accounting. 

This has been a guide to what is Avoidable Cost & its meaning. Here, we explain its formula, strategy, examples, and comparison with unavoidable costs. You can learn more about it from the following articles –

Reader Interactions

Leave a Reply

Your email address will not be published. Required fields are marked *