Month: February 2021

Cost-volume-profit (CVP) analysis is used to determine how changes in costs and volume affect a company’s operating income and net income. In performing this analysis, there are several assumptions made, including:

• Sales price per unit is constant.
• Variable costs per unit are constant.
• Total fixed costs are constant.
• Everything produced is sold.
• Costs are only affected because activity changes.
• If a company sells more than one product, they are sold in the same mix.

In economics, the Cost Analysis refers to the measure of the cost – output relationship, i.e. the economists are concerned with determining the cost incurred in hiring the inputs and how well these can be re-arranged to increase the productivity (output) of the firm.

In other words, the cost analysis is concerned with determining money value of inputs (labor, raw material), called as the overall cost of production which helps in deciding the optimum level of production.

There are several cost concepts relevant to the business operations and decisions and for the convenience of understanding these can be grouped under two overlapping categories:

Cost Concepts Used for Accounting Purposes: Generally, the accountants use these cost concepts to study the financial position of the firm. They are concerned with arranging the finances of the firm and therefore keep a track of the assets and liabilities of the firm. The accounting costs are used for taxation purposes and calculating the profit and loss of the firm. These are:

• Opportunity Cost
• Business Cost
• Full Cost
• Explicit Cost
• Implicit Cost
• Out-of-Pocket Cost
• Book Cost

Analytical Cost Concepts Used for Economic Analysis of Business Activities: These cost concepts are used by the economists to analyze the likely cost of production in the future. They are concerned with how the cost of production can be managed or how the input and output can be re-arranged such that the overall profitability of the firm gets improved. These costs are:

• Fixed Cost
• Variable Cost
• Total Cost
• Average Cost
• Marginal Cost
• Short-run Cost
• Long-Run Cost
• Incremental Cost
• Sunk Cost
• Historical Cost
• Replacement Cost
• Private Cost
• Social Cost

In business, the manager must have a clear understanding of the cost-output relation as it helps in cost control, marketing, pricing, profit, production, etc. The cost-output relation can be expressed as:

C = f (S, O, P, T)

Where, C =cost, S = Size of the firm, O = output, P = Price and T = Technology.

With the increase in the size of the firm, the economies of scale also increase and as a result the cost of per unit production comes down. There is a positive relation between the cost and the output, as the output increases the cost also increases and vice-versa. Likewise, the price of inputs is directly related to the price, as the input price increases the cost of production also increases. But however, the technology is inversely related to the cost, i.e. with an improved technology the cost of production decreases.

Thus, the cost analysis is pivotal in business decision-making as the cost incurred in the input and output is to be carefully understood before planning the production capacity of the firm.

Importance of Cost Volume Profit Analysis

CVP analysis helps in determining the level at which all relevant cost is recovered, and there is no profit or loss, which is also called the breakeven point. It is that point at which volume of sales equals total expenses (both fixed and variable). Thus CVP analysis helps decision-makers understand the effect of a change in sales volume, price, and variable cost on the profit of an entity while taking fixed cost as unchangeable.

CVP Analysis helps in understanding the relationship between profits and costs on the one hand and volume on the other. CVP Analysis is useful for setting up flexible budgets that indicate costs at various levels of activity. CVP Analysis also helpful when a business is trying to determine the level of sales to reach a targeted income.

Understanding Investment Centers

The different departmental units within a company are categorized as either generating profits or running expenses. Organizational departments are classified into three different units: cost center, profit center, and investment center. A cost center focuses on minimizing costs and is assessed by how much expenses it incurs.

Examples of departments that make up the cost center are the human resource and marketing departments. A profit center is evaluated on the amount of profit that is generated and attempts to increase profits by increasing sales or reducing costs. Units that fall under a profit center include the manufacturing and sales department. In addition to departments, profit and cost centers can be divisions, projects, teams, subsidiary companies, production lines, or machines.

An investment center is a center that is responsible for its own revenues, expenses, and assets and manages its own financial statements which are typically a balance sheet and an income statement. Because costs, revenue, and assets have to be identified separately, an investment center would usually be a subsidiary company or a division.

One can classify an investment center as an extension of the profit center where revenues and expenses are measured. However, only in an investment center are the assets employed also measured and compared to the profit made.

Investment Center vs. Profit Center

Instead of looking at how much profit or expenses a unit has as with a firm’s profit centers, the investment center focuses on generating returns on the fixed assets or working capital invested specifically in the investment center.

Unlike a profit center, an investment center might invest in activities and assets that are not necessarily related to the company’s operations. It could be investments or acquisitions of other companies enabling diversification of the company’s risk. A new trend is the proliferation of venture arms within established corporations to enable investments in the next wave of trends through acquiring stakes in startups.

In simpler terms, the performance of a department is analyzed by examining the assets and resources given to the department and how well it used those assets to generate revenues compared with its overall expenses. By focusing on return on capital, the investment center philosophy gives a more accurate picture of how much a division is contributing to the economic well-being of the company.

Using this approach of measuring a department’s performance, managers have insight as to whether to increase capital to increase profits or whether to shut down a department that is inefficiently making use of its invested capital. An investment center that cannot earn a return on invested funds in excess of the cost of those funds is deemed not economically profitable.

Investment Center vs. Cost Center

An investment center is different from a cost center, which does not directly contribute to the company’s profit and is evaluated according to the cost it incurs to run its operations. Moreover, unlike a profit center, investment centers can utilize capital in order to purchase other assets.

Because of this complexity, companies have to use a variety of metrics, including return on investment (ROI), residual income, and economic value added (EVA) to evaluate the performance of a department. For example, a manager can compare the ROI to the cost of capital to evaluate a division’s performance. If the ROI is 9% and the cost of capital is 13%, the manager can conclude that the investment center is managing its capital or assets poorly.

Profit centers

Profit centers are businesses within a larger business, such as the individual stores that make up a mall, whose managers enjoy control over their own revenues and expenses. They often select the merchandise to buy and sell, and they have the power to set their own prices.

Profit centers are evaluated based on controllable margin; the difference between controllable revenues and controllable costs. Exclude all noncontrollable costs, such as allocated overhead or other indirect fixed costs, from the evaluation. The beautiful thing about running a profit center is that doing so gives managers an incentive to do exactly what the company wants: earn profits.

Classifying responsibility centers as profit centers has disadvantages. Although they get evaluated based on revenues and expenses, no one pays attention to their use of assets. This scenario gives managers an incentive to use excessive assets to boost profits.

For managers, the upside of using more assets is the resulting increases in sales and profits. What’s the downside? Well, nothing; managers of profit centers aren’t held accountable for the assets that they use.

This flaw in the evaluation of profit centers can be addressed by carefully monitoring how profit centers use assets or by simply reclassifying a profit center as an investment center.

Investment centers

You could call investment centers the luxury cars of responsibility centers because they feature everything. Managers of investment centers have authority over and are held responsible for revenues, expenses, and investments made in their centers. Return on investment (ROI) is often used to evaluate their performance.

To improve return on investment, the manager can either increase controllable margin (profits) or decrease average operating assets (improve productivity).

Using return on investment to evaluate investment centers addresses many of the drawbacks involved in evaluating revenue centers, costs centers, and profit centers. However, classification as an investment center can encourage managers to emphasize productivity over profitability to work harder to reduce assets (which increases ROI) rather than to increase overall profitability.

Restructuring is the corporate management term for the act of reorganizing the legal, ownership, operational, or other structures of a company for the purpose of making it more profitable, or better organized for its present needs. Other reasons for restructuring include a change of ownership or ownership structure, demerger, or a response to a crisis or major change in the business such as bankruptcy, repositioning, or buyout. Restructuring may also be described as corporate restructuring, debt restructuring and financial restructuring.

Types of Corporate Restructuring

There are generally two different forms of corporate restructuring; the reason for restructuring will determine both the type of restructuring and the corporate restructuring strategy:

Financial restructuring may occur to changes in the market or legal environment and are needed in order for the business to survive. . For example, a corporate entity may choose to restructure their debt to take advantage of lower interest rates or to free up cash to invest in current opportunities. .

Organizational restructuring is often implemented for financial reasons as well but focuses on altering the structure of the company rather than its financial arrangements. Legal entity restructuring is one of the most common types of organizational restructuring. Two common examples of restructuring are in the sales tax and property tax arenas. The first involves creation of a leasing company for operating assets that can allow for sales and income tax savings. In the second example, for property taxation, restructuring can change the method of taxation or create a revaluation opportunity to improve reporting positions.

Reasons

Change in business strategy: A company may choose to eliminate subsidiaries or divisions that do not align with its core strategy and long-term vision and raise capital to support advancing the core strategy. Additionally, corporate strategy can be to maximize tax opportunities or improve flexibility.

Improvement of profits: If a company isn’t properly deploying its assets to maximize profit, restructuring may be pursued to get the company on a more solid financial footing. The direction the company takes in its restructuring will be determined by the corporate strategy that best employs the resources available.

Cash flow requirements: Divestment of underperforming or unprofitable divisions or subsidiaries can provide liquidity that the corporate entity cannot access otherwise. The sale of some assets can provide both an influx of cash and reduction of debt, giving the corporate entity easier access to financing and/or more favorable terms.

Reverse synergy: Just as companies sometimes seek mergers and acquisitions to create business synergies, the reverse is also true. Sometimes, the value of a merged or conglomerate unit is less than the value of its individual parts. Some divisions or subsidiaries may have more value in a sale than they do as a part of the larger corporate entity.

Characteristics of Corporate Restructuring:

• Reapproaching his duties, such as professional financial help, to an increasingly productive outsider.
• Workers decrease the number of lay-offs (by cut-off or auction-off)
• Developments in the management of businesses.
• Discarding, for example, brands/patents protection, underused tools.
• Renewal of resources, such as the promotion, transaction, and dissemination of information.
• Overhead reduction renegotiation of work agreements.
• The rearrangement or renegotiation of the intrigue installment limitation obligation.
• Transfer of tasks, for instance, move the assembly to reduce costs.
• Push a marketing campaign as a brand revival to its clients everywhere.
• Cash management and cash generation during crisis
• Impaired Loan Advisory Services (ILAS)
• Retention of corporate management in the form of “stay bonus” payments or equity grants
• Sale of underutilized assets, such as patents or brands
• Outsourcing of operations such as payroll and technical support to a more efficient third party
• Moving of operations such as manufacturing to lower-cost locations
• Reorganization of functions such as sales, marketing, and distribution
• Renegotiation of labor contracts to reduce overhead
• Refinancing of corporate debt to reduce interest payments
• A major public relations campaign to reposition the company with consumers
• Forfeiture of all or part of the ownership share by pre-restructuring stock holders (if the remainder represents only a fraction of the original firm, it is termed a stub)
• Improving the efficiency and productivity through new investments, R&D and business engineering.

Financial Restructuring: Debt Loading

Alternatively, a corporation may load the balance sheet with debt to finance the buyout of existing shareholders. This debt loading strategy often is referred to as a leveraged buyout. Companies use the debt loading strategy to enable one founder to buy out the shares of his co-founders. The corporation repurchases and retires the shares and then uses its cash flow to pay down the debt. Of course, incurring additional debt has other consequences.

Financial Restructuring: Debt Swap

When corporations use a financial restructuring strategy, they change the company’s capital structure. They may replace debt with equity. When a company swaps out its debt, it eliminates existing shareholders. In lieu of a liquidation or bankruptcy, the debt holders take over the company’s assets and obtain a claim on future earnings in the form of newly issued shares. Debt holders often accept this arrangement when the elimination of the interest and principal payments significantly strengthens the company’s financial position. Shareholders typically receive nothing.

Portfolio Restructuring

A divestiture strategy is a type of portfolio restructuring strategy. Companies sell, shut down or spin off unprofitable, money-losing divisions and subsidiaries or those that no longer fit its strategy. Portfolio restructuring allows a corporation to refocus on its core activities and raise much needed capital. It can use the proceeds of these transactions to strengthen its core business or acquire other businesses that closely fit its strategy and contribute to a profitable bottom line.

Corporate Restructuring

Money related Restructuring

This form of reconstruction may occur due to a serious fall in general transactions in the light of unfavorable financial conditions. The corporate substance can change its concept of value, its adjustment plan for obligations, the value property and its cross-holding design. This is to help the business and the organization’s advantage.

Hierarchical Restructuring

Organizational reform proposes an alteration of an organization’s authoritative structure.

Divesting in assets

There are different ways a company can reduce its size. The methods by which a division is isolated from its operations are as follows:

Divestitures

A corporation sells, liquidates or spins a subsidiary or a division under divestitures. The divestiture standard is usually the direct selling of the divisions to an external buyer. The selling company collects cash compensation and ownership of the division is passed to the new purchaser.

Equity Carve-outs

With equity carvings, a new and independent business is formed by diluting the equity interest in the division and the sale to external shareholders. The new subsidiary’s shares are sold in a general public offer, and the new subsidiary, with operations and management removed from the corporation, becomes a distinct legal entity.

Spin-offs

The corporation establishes a new entity under by-products, which is different from the initial business of equity carve-outs. The critical difference is that the shares are not sold in public. Instead, the stakes are allocated proportionately to existing shareholders. This ensures that the same investment base as the original company is entirely separate from operations and management. Since the new subsidiary’s stocks are sold to its shareholders, this exchange does not reimburse the corporation for cash.

Split-offs

With split-offs, shareholders receive new trading stocks for their existing stocks in the company by the company’s subsidiary. The rationale here is that the shareholders leave the company to accept the new subsidiary stocks.

Liquidation

A business is broken down under liquidation and properties or units are sold piece by piece. Liquidations are commonly synonymous with bankruptcies.

Core competencies are the resources and capabilities that comprise the strategic advantages of a business. A modern management theory argues that a business must define, cultivate, and exploit its core competencies in order to succeed against the competition.

Core competency is a unique skill or technology that creates distinct customer value. For instance, core competency of Federal express is logistics management. The organizational unique capabilities are mainly personified in the collective knowledge of people as well as the organizational system that influences the way the employees interact. As an organization grows, develops and adjusts to the new environment, so do its core competencies also adjust and change. Thus, core competencies are flexible and developing with time. They do not remain rigid and fixed. The organization can make maximum utilization of the given resources and relate them to new opportunities thrown by the environment.

A variation of the principle that has emerged in recent years recommends that job seekers focus on their personal core competencies in order to stand out from the crowd. These positive characteristics may be developed and listed on a resume. Some personal core competencies include analytical abilities, creative thinking, and problem resolution skills.

Resources and capabilities are the building blocks upon which an organization create and execute value-adding strategy so that an organization can earn reasonable returns and achieve strategic competitiveness.

Three conditions a business activity must meet in order to be a core competency:

• The activity must provide superior value or benefits to the consumer.
• It should be difficult for a competitor to replicate or imitate it.
• It should be rare.

Core Functions:

Core functions lay emphasis on the nature of the business. At this stage the firm has to clearly identify its courses of actions with respect to strategy planning, research and development, and product development.

Customer Delivery Function:

This step emphasises more on value addition with various activities such as marketing, sales, manufacturing, quality assurance and control, sourcing, procurement, engineering and maintenance, customer service and technical support etc. Excellence in these activities can create a sort of competitive advantage for the firm if it could harness its resources intelligently than its competitors.

Support Functions:

As the name suggests, to support the core activities of business some secondary activities are to be carried out which include IT, Finance and Accounting, HR management, General administration etc.

These activities will facilitate the performance of the core activities in a way that goals of the firm can be accomplished successfully without wasting limited resources. They will also help in synchronizing the different tasks which are to be carried out simultaneously to become cost leader.

Resources are inputs to a firm in the production process. These can be human, financial, technological, physical or organizational. The more unique, valuable and firm specialized the resources are, the more possibly the firm will have core competency. Resources should be used to build on the strengths and remove the firm’s weaknesses. Capabilities refer to organizational skills at integrating it’s team of resources so that they can be used more efficiently and effectively.

Organizational capabilities are generally a result of organizational system, processes and control mechanisms. These are intangible in nature. It might be that a firm has unique and valuable resources, but if it lacks the capability to utilize those resources productively and effectively, then the firm cannot create core competency. The organizational strategies may develop new resources and capabilities or it might make stronger the existing resources and capabilities, hence building the core competencies of the organization.

Core competencies help an organization to distinguish its products from it’s rivals as well as to reduce its costs than its competitors and thereby attain a competitive advantage. It helps in creating customer value. Also, core competencies help in creating and developing new goods and services. Core competencies decide the future of the organization. These decide the features and structure of global competitive organization. Core competencies give way to innovations. Using core competencies, new technologies can be developed. They ensure delivery of quality products and services to the clients.

Core Competency Theory

The core competency theory is the theory of strategy that prescribes actions to be taken by firms to achieve competitive advantage in the marketplace. The concept of core competency states that firms must play to their strengths or those areas or functions in which they have competencies. In addition, the theory also defines what forms a core competency and this is to do with it being not easy for competitors to imitate, it can be reused across the markets that the firm caters to and the products it makes, and it must add value to the end user or the consumers who get benefit from it. In other words, companies must orient their strategies to tap into the core competencies and the core competency is the fundamental basis for the value added by the firm.

Core Competencies and Strategy

The term core competency was coined by the leading management experts, CK Prahalad and Gary Hamel in an article in the famous Harvard Business Review. By providing a basis for firms to compete and achieve sustainable competitive advantage, Prahalad and Hamel pioneered the concept and laid the foundation for companies to follow in practice.

Some core competencies that firms might have include technical superiority, its customer relationship management, and processes that are vastly efficient. In other words, each firm has a specific area in which it does well relative to its competitors, this area of excellence can be reused by the firm in other markets and products, and finally, the area of strength adds value to the consumer. The implications for real world practice are that core competencies must be nurtured and the business model built around them instead of focusing too much on areas where the firm does not have competency. This is not to say that other competencies must be neglected or ignored. Rather, the idea behind the concept is that firms must leverage upon their core strengths and play to their advantages.

Six Sigma (6σ) is a set of techniques and tools for process improvement. It was introduced by American engineer Bill Smith while working at Motorola in 1986. Jack Welch made it central to his business strategy at General Electric in 1995. A six sigma process is one in which 99.99966% of all opportunities to produce some feature of a part are statistically expected to be free of defects.

The method uses a data-driven review to limit mistakes or defects in a corporate or business process. Six Sigma emphasizes cycle-time improvement while at the same time reducing manufacturing defects to a level of no more than 3.4 occurrences per million units or events. In other words, the system is a method to work faster with fewer mistakes.

Six Sigma points to the fact that, mathematically, it would take a six-standard-deviation event from the mean for an error to happen. Because only 3.4 out of a million randomly (and normally) distributed, events along a bell curve would fall outside of six-standard-deviations (where sigma stands in for “standard deviation”).

Six Sigma strategies seek to improve the quality of the output of a process by identifying and removing the causes of defects and minimizing impact variability in manufacturing and business processes. It uses a set of quality management methods, mainly empirical, statistical methods, and creates a special infrastructure of people within the organization who are experts in these methods.

Each Six Sigma project carried out within an organization follows a defined sequence of steps and has specific value targets, for example:

1) Reduce process cycle time

2) Reduce pollution

3) Reduce costs

4) Increase customer satisfaction

5) Increase profits.

The term Six Sigma (capitalized because it was written that way when registered as a Motorola trademark on December 28, 1993) originated from terminology associated with statistical modeling of manufacturing processes. The maturity of a manufacturing process can be described by a sigma rating indicating its yield or the percentage of defect-free products it creates specifically, to within how many standard deviations of a normal distribution the fraction of defect-free outcomes corresponds. Motorola set a goal of “six sigma” for all of its manufacturing.

The DMAIC project methodology has five phases:

• Define the system, the voice of the customer and their requirements, and the project goals, specifically.
• Measure key aspects of the current process and collect relevant data; calculate the ‘as-is’ Process Capability.
• Analyze the data to investigate and verify cause-and-effect relationships. Determine what the relationships are, and attempt to ensure that all factors have been considered. Seek out root cause of the defect under investigation.
• Improve or optimize the current process based upon data analysis using techniques such as design of experiments, poka yoke or mistake proofing, and standard work to create a new, future state process. Set up pilot runs to establish process capability.
• Control the future state process to ensure that any deviations from the target are corrected before they result in defects. Implement control systems such as statistical process control, production boards, visual workplaces, and continuously monitor the process. This process is repeated until the desired quality level is obtained.

DMADV

The DMADV project methodology, known as DFSS (“Design For Six Sigma”), features five phases:

• Define design goals that are consistent with customer demands and the enterprise strategy.
• Measure and identify CTQs, measure product capabilities, production process capability, and measure risks.
• Analyze to develop and design alternatives
• Design an improved alternative, best suited per analysis in the previous step
• Verify the design, set up pilot runs, implement the production process and hand it over to the process owners.

Six Sigma identifies several key roles for its successful implementation.

• Executive Leadership includes the CEO and other members of top management. They are responsible for setting up a vision for Six Sigma implementation. They also empower the other role holders with the freedom and resources to explore new ideas for breakthrough improvements by transcending departmental barriers and overcoming inherent resistance to change.
• Champions take responsibility for Six Sigma implementation across the organization in an integrated manner. The Executive Leadership draws them from upper management. Champions also act as mentors to Black Belts.
• Master Black Belts, identified by Champions, act as in-house coaches on Six Sigma. They devote 100% of their time to Six Sigma. They assist Champions and guide Black Belts and Green Belts. Apart from statistical tasks, they spend their time on ensuring consistent application of Six Sigma across various functions and departments.
• Black Belts operate under Master Black Belts to apply Six Sigma methodology to specific projects. They also devote 100% of their time to Six Sigma. They primarily focus on Six Sigma project execution and special leadership with special tasks, whereas Champions and Master Black Belts focus on identifying projects/functions for Six Sigma.
• Green Belts are the employees who take up Six Sigma implementation along with their other job responsibilities, operating under the guidance of Black Belts.

Finance

Six Sigma has played an important role by improving accuracy of allocation of cash to reduce bank charges, automatic payments, improving accuracy of reporting, reducing documentary credits defects, reducing check collection defects, and reducing variation in collector performance. Two of the financial institutions that have reported considerable improvements in their operations are Bank of America and American Express. By 2004 Bank of America increased customer satisfaction by 10.4% and decreased customer issues by 24% by applying Six Sigma tools in their streamline operations. Similarly, American Express successfully eliminated non-received renewal credit cards and improved their overall processes by applying Six Sigma principles. This strategy is also currently being applied by other financial institutions like GE Capital Corp., JP Morgan Chase, and SunTrust Bank, with customer satisfaction being their main objective.

Strategic advantages of Cost Management

• It helps in analyzing the business positioning in terms of making an acquisition factoring the cost component involved.
• One can predict the future expenses and costs and accordingly work towards the expected revenues.
• Predefined costs can be maintained as records for the business.
• It helps in controlling the project specific cost, in turn also the overall business cost.
• It helps in taking those actions that are necessary to assure that the resources and business operations aim at attaining the chalked objectives and goals.
• It helps in analysing the long-term trends of the business.
• The actual cost incurred can be compared to the budgeted to see if any component of the business is spending more than expected.

Long-term perspective of Cost Management

Strategic Cost Analysis is a comparison of one entity’s cost position to another. Cost analysis compares everything from the price paid for raw materials right to the price customers pay for the finished product. The goal of the analysis is to determine whether or not one company’s costs are competitive with another’s.

No company can totally avoid the impact of increasing costs. And most managers have learned to adjust to the effect inflation has on current operating costs. But few have factored it into their competitive strategies. And most managers, particularly those in capital-intensive industries, have not paid enough attention to the way increasing capital requirements affect their ability to compete in the long run.

Strategic cost management is the process of reducing total costs while improving the strategic position of a business. This goal can be accomplished by having a thorough understanding of which costs support a company’s strategic position and which costs either weaken it or have no impact. Subsequent cost reduction initiatives should focus on those costs in the second category. Conversely, it may be useful to increase costs that support the strategic position of the business.

There are the following steps required in strategic cost analysis:

• Identify the appropriate value chain and assign costs and assets to it.
• Diagnose the costs drivers of each value activity and how they interact.
• Identify competitor value chains, and determine the relative cost of competitors and the sources of cost differences.
• Develop a strategy to lower relative cost position through controlling cost drivers or reconfiguring the value chain and/or downstream value.
• Ensure that cost reduction efforts do not erode differentiation, or make a conscious choice to do so.
• Test the cost reduction strategy for sustainability.

Strategic Cost Analysis helps companies identify, analyse, and use strategically important resources for continuing success and growth of the business.

This type of analysis may be used to review the overall direction of the company as the result of a merger, acquisition or take-over. It may be part of a strategic planning exercise or may simply be necessary as a major investment or divestment decision is to be made. It can also be used to provide consistent information for cost/benefit evaluations.

Activity-based Costing (ABC) can be used to provide the cost data required to focus attention on those factors that determine the expenditure on key projects or activities. It can help in the cost/benefit analysis of individual projects and hence assist the prioritisation of alternative projects, managing resources to maximise the return on investment in line with the strategic direction of the institution.

It can be used to determine when costs should be incurred (such as, when to diversify and move into a new business area). This will enable management to manage costs on the basis of spending (the investment in a new market or business activity) not consumption (the operation of the business).

An organisation creates a competitive advantage through the use of resources to provide products and services which meet customer needs. The resources consumed to create these attributes are not free, and the effective use of the resources is critical in any competitive environment. The value of a cost management system comes from the way management uses it to support decision making, including decisions about long-term strategy.