Cost Management (Definition, Examples)

What is Cost Management?

Cost management is an integral part of the business management that works on the basis of estimations, wherein various activities such as collecting the data, analyzing the data and mechanisms, evaluation of the process and reporting of the events are conducted so that the decision-maker can plan & control the budget requirements of the organization and thereby, enabling the decision-maker to decide whether the project can be completed within the specified time and within the specified budget.

Explanation

Before drilling down into the topic of “cost management”, let’s have a quick glimpse over “what is a cost”. Now, the “Cost” is nothing but measure (in terms of money) of efforts, materials, resources, time consumed (hours or days or weeks or months), risk and opportunity are forgone in production or delivery of a product. That means it is the amount that paid or given up for something to be acquired.
Coming back to the topic, This is the management of the various components of the cost involved in the manufacture of the product or delivery of service.
The objective of the management process is not reducing the costs but reducing the cost only up to the stage where the quality of the product is not hampered.

Features

Planning: Here, a plan or set of targets is framed. The framework includes the budgets, standards or estimates.
Communication: Here, the above-made plan is communicated to those who are actually going to implement the plan.
Motivation: Here, the plan is evaluated for its performance.
Appraisal: Comparison is being made with the predetermined targets and the actual performance.
Decision-Making: Here, corrective actions are taken or the set of targets is revised, depending upon the requirement of the task.

Process

#1 – Resource Allocation

Here, we ascertain the future resource requirements depending upon the scope of work. Resources such as physical, financial, human and information are required to accomplish the basic targets. In the majority of the cases, Human resources are of utmost importance. On the other hand, few tasks require the use of material and consumables. However, few tasks may be performed by automated tools that may not require any human intervention.

#2 – Cost Estimating

It is the prediction of quantity, cost and the price of the resources to be used in the project. It involves various techniques wherein the non-financial information about the project is converted into financial information. Such outputs are primarily used as inputs for planning and analyzing the overall project cost.

#3 – Cost Budgeting

It is a part and parcel of cost estimation. However, in cost budgeting, the overall cost is allocated to the cost accounts. Then, the cost accounts are taken as a basis for cost control for comparison. Also, cost accounts have a secondary purpose i.e. to support the cost accounting process. Budgeting each cost in advance is necessary since the production process is time-bound. It is important to address the cash flow constraints as well.

#4 – Cost Control

The basis made above (i.e. cost accounts) is used to compare and evaluate the variances. Variances are analyzed to grab the least possible cost without hampering the quality of the end product of the organization. Expenditures and performances are monitored in comparison with the progress of the project. Based on the variances, suitable & corrective action is taken so as to avoid exceeding the budgets. When the actual cost is incurred, the cost control mechanism helps to analyze the variances.

#5 – Benchmarking

Benchmarking means a minimum target to be achieved. Benchmarks are nothing but records of the high performing activities or tasks or the people. Benchmark helps to increase the overall project performance and thereby increasing the value of the project. Benchmarks can also be interchanged between two projects, wherein one of the projects is complete in all material respects.

Cost Management Techniques with Examples

Let’s have a glimpse over these techniques with examples:

These techniques are used for the management of cost. Let`s take an example on target costing as below:

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The company wants to launch a new product named “DD” (franchisee). The company is required to pay a royalty of 15% on selling price to the franchisee owner. The expected selling price = $ 100 per item & the profit percentage is 25% on the selling price. The cost details are as follows:

The question is determining the target cost & the possible cost reduction.

Solution

Calculate Target Cost

Calculate Actual Cost Structure

= 63-60
= 3

Thus, as per the target cost management technique, the company is expected to reduce the cost by reducing the manufacturing costs by $ 3 only.

Factors Affecting the Cost Management

Growth in information technology
Global and overall domestic competition
Growth of service and manufacturing sectors
Growth in the global competitiveness
Growth of the service sector
Theory of constraints which is used in the identification of critical resources
Customer focus
Research & development of new products

Importance

Joe Biden rightly said once that, “Don’t tell me what you value, show me your budget, and I’ll tell you what you value.”

So, no project starts without placing the budget. The success of the project is decided by how well the project cost has been handled in the project. It could happen that the project may not be completed within the project cost. It means that project costs might have exceeded and if this happens, it is of course considered as a project failure. Thus, it is important to correctly estimate the cost.
If the starting point i.e. planning and estimation go wrong, other points are not useful. Further, implementing cost reduction without the focus on its management, will not serve the purpose.

Differences Between Cost Management and Cost Control

There is some difference between “giving directions to a team” and “leading a team”. Do you realize the difference in the way things are carried out by each team? A similar type of difference arises in Cost management vs cost control. Both seem to be a synonym with each other. However, they are not. There is a difference between managing the cost and controlling the cost.

#1 – Cost Management

As explained earlier, It is mainly concerned with the stagewise processes wherein planning and controlling the budget of a project is of utmost importance. This focuses on keeping all the things within the approved budget. Things start from the initial phase of planning and end with the performance evaluation after project completion.

#2 – Cost Control

Cost control, on the other hand, has main concerns with taking appropriate actions with the objective of minimizing the cost of products. Variances are analyzed to monitor the expenses & performance. Based on the analysis appropriate actions are required to be taken. Cost control deals with what has to be done, what has been done, what remains to be done, the implementation of corrective actions and checking the corrective actions. So, if you observe, cost control is focussed on limiting the project during the execution phase but its effectiveness is computed by cost management processes.

Advantages

It helps in controlling the project-specific cost and thereby it also controls the overall business cost.
Prediction of future expenses and costs is possible. Thus, the expected revenue can be computed easily.
Predefined costs can be treated as the records for the business.
It helps in taking those action-points which are necessary to assure that, the resources and business operations are in line to achieve the predefined objectives and goals.
It helps in analyzing the long-term trends of the business.
The actual cost incurred can be compared to the budgeted to find out the variances. These variances help to identify whether spending exceeds more than what was expected.
It also looks at the external factors of competition, market growth, customer requirements, quality of the product, service delivery, etc. and not just on cost reduction.
It helps in product differentiation as well as cost reduction.
It further guides in continuous improvement to deliver a superior product in terms of quality.

Conclusion

Management has its own importance in every aspect of our life. In the end, it’s all about who manages the things. And hence, management is also critical in terms of cost involved in the project. It has greater significance than cost control or cost reduction. These techniques help to achieve said purpose easily.

Cost Management