Areas covered by cost control and cost reduction

Some of the areas where a cost control is essential in a Business are:

(I) Labour

(ii) Materials

(iii) Sales

(iv) Overheads

(v) Energy

Costs have been rising faster than ever before. The business executives have neglected the more important task of providing effective information to management for the control and reduction of costs. The management and control of the resources used in most business firms leaves a great deal to be desired.

(i) Labour:

Labour costs have risen in three ways:

(a) Higher basic pay,

(b) Shorter working hours, and

(c) Reduced output.

Reducing labour cost is a little tricky question. It is not possible to reduce wage rates due to the existence of trade unions and minimum wage legislations. The policy of wage reduction is also counter­productive for a management. So to motivate the workers, wage rates would need to be revised up­wards. The reduction in labour costs would be possible only if over time, the rate of output per worker increases faster than the wage rate increase. This is possible by raising labour productivity.

Productivity schemes aimed at paying for more output are self-defeating unless the net result is a reduction in unit cost.

Productivity must be seen as one or other of the following:

(i) Producing more for the same cost, or

(ii) producing the same for a lower cost.

Productivity should mean lower unit costs it is, in other words, cost reduction. This means finding better ways of doing things so that production increases for each hour’s efforts expanded. This is the only way to defeat rising labour costs.

(ii) Material:

The inefficient use of materials is one of the prime causes of increased costs. Wastage through poor control and design has risen to such an extent that waste recovery is now a major industry. Waste must be controlled if costs are to be contained.

The price paid for materials is affected by commodity markets. There are different ways of reducing material cost. If purchasing of materials is done properly, the firm can get various types of discounts. A number of decisions are involved in the case of materials used by a firm.

• Firstly, the sources where materials are available will have to be identified.
• Secondly, a cheaper substitute available to the material being presently used by the firm has to be found out.
• Thirdly, the cost of freight has to be examined.
• Fourthly, a suitable product design to reduce the material usage is needed.
• Fifthly, alternative process of production has to be examined.

Since material cost form a major part of the total cost of production, control and reduction of material cost in these cases is of vital importance. R&D efforts, inventory management, improved production planning, elimination of slow moving stocks, and improved flow of parts and materials, etc. can be effective in controlling and reducing these costs.

(iii) Sales:

Sales are another area which needs monitoring of costs. Sales control requires making sure that the company is not over-spending to achieve its sales goals. In order to sell, a firm maintains a sales force and spends on advertisement, etc. The key ratio to watch is marketing expense to sales.

It consists of five component expenses to sales ratios:

(i) Sales force to sales

(ii) Advertising to sales

(iii) Sales promotion to sales

(iv) Marketing research to sales

(v) Sales administration to sales.

Management needs to monitor these marketing expense ratios. Sales cost can be controlled by rearranging market segments as the basis of demand. It should reschedule the sales force based on suitability of each member of the team. Peculiarities of consumer choices must be ascertained and communicated to the management, so that products are altered according to consumer needs.

(iv) Overheads:

Overhead costs are fixed costs. Fixed costs are defined as those which remain the same at a given capacity and do not vary with output. These costs will exist even if no output is produced. A proper selection of capacity, a right choice of equipment and its proper maintenance are likely to keep over­heads down.

The costs of plant, equipment and building, etc. are examples of fixed cost. Included in them are costs that require a fixed amount of funds in each period without reference to output such as rent, depreciation charges, property taxes and salaries of employees who cannot be retrenched during peri­ods of reduced demand. Careful planning is required regarding the complete layout of the plants. The overhead costs can be reduced by means of effective planning and implementation.

(v) Energy:

Faulty designs result in excessive use of power and materials. Lighting costs can be reduced by high quality electronic energy saving light bulbs. The increase in oil prices has shown the very high levels of waste. The problem of energy conservation is attracting considerable interest because high prices warrant some action.

The costs of reducing the consumption of energy can now be offset by the savings. Yet there has always been value in reducing energy consumption. Changing attitudes towards the use of what has always been cheap and plentiful is difficult, yet the task must be tackled if the pressure on profits is to be reduced.

It is stated that, in India, there is no economy in the use of fuel, energy or power. Fuel wastage in Indian industry is as high as 25 per cent. All these areas of rising costs must be tackled if industry and commerce hope to survive intact. They can only be tackled if a continuous examination of resource consumption is instituted. Only a well thought out and continuous cost reduction programme will produce the necessary long term benefits.

Cost Reduction Program

Followings are the essentials of a cost reduction program:

• Cost reduction program should be according to requirement of the company.
• Cost reduction program is a continuous activity that cannot be treated as one time or short-term activity. Success of any cost reduction program may lie in only continuous improvement of efforts.
• Cost reduction program should be real and permanent.
• Example setter of cost reduction program should be top management employee. Success of this program depends on co-operation of all employees and department of an organization.
• Employees should be rewarded for their participation in cost reduction program and for giving innovative ideas related to this program.

Fields Covered under the Cost Reduction Program

A number of fields come under the scope of cost reduction. They are discussed below.

Design

Manufacturing of any product starts with the design of product. At the time of improvement in design of old product as well as at the time of designing new product, some investment is recommended to find a useful design that may reduce the cost of the product in following terms:

Material Cost

Design of product should encourage to find out possibility of cheaper raw material as a substitute, maximum production, less quantity etc.

Labor Cost

Design of product may reduce time of operation, cost of after-sale service, minimum tolerance, etc.

Organization

Employees should be encouraged for cost reduction scheme. There should be no scope for doubts and frictions; there should be no communication gap between any department or any level of management; and there must be proper delegation of responsibilities with defined area of functions of an organization.

Factory Layout and Equipment

There should be a proper study about unused utilization of material, manpower and machines, maximum utilization of all above may reduce cost of any product effectively.

Administration

An organization should make efforts to reduce the cost of administrative expenses, as there is ample scope to do so. A company may evaluate and reduce the cost of following expenses, but not the cost of efficiency:

• Telephone expenses
• Travelling expenses
• Salary by reducing staff
• Reduction in cost of stationery
• Postage and Telegrams

Marketing

Following areas can be covered under the cost reduction program:

• Advertisement
• Warehouse
• Sales Promotion
• Distribution Expenses
• Research & Development Program

Any cost accountant should keep the following points in mind while focusing on cost reduction for the Marketing segment:

• Check the distribution system of an organization about the overall efficiency of the system and how economically that system is working.
• Find out the efficiency of the sales promotion system
• Find out if the costs can reduced from the sales and distribution system of an organization and whether the research and development system of market is sufficient.
• A cost accountant should also do an ABC analysis of customers in which customers may be divided into three categories. For example:

ABC Analysis of Customers
Category	Number of Dispatches	Volume of Sale Covered
Customer…A	About 10%	60% to 80%
Customer…B	About 20%	20% to 30%
Customer…C	About 70%	5% to 10%

After performing this analysis, the organization can focus on the customers who are covering most of the sales volume. According to it, the cost reduction program may be run successfully in the area of category B and C.

Financial Management

Attention should be given to the following areas:

• If there is any over-investment.
• How much economical is the cost of capital received?
• If the organization is getting maximum returns for the capital employed.
• If there is any over-investment, that should be sold and similarly, unutilized fixed assets should be eliminated. Slow-moving or non-moving inventories should be removed and should transfer this surplus to the working capital to re-invest it in a cycle of more profitable area of business.

Personal Management

Cost reduction programs can be run using staff welfare measures and improving labor relation. Introduction of incentive schemes for labor and giving them better working conditions is very important to run an efficient cost reduction program.

Material Control

Cost reduction program should be run by purchasing economical and more useful material. Economic Order Quantity (EOQ) technique should be used. Inventory should be kept low. Proper check on inward material, control over warehouse and proper issuance of material, and effective material yield should be done.

Production

Using effective control over material, labor, and machine a better cost reduction program may be run.