Cost management definition
/What is Cost Management?
Cost management is the control of actual or forecasted costs incurred by a business. It is essential for a company to employ proper cost management, or else it will have difficulty consistently generating a profit. This concept is best applied as a formalized process, using some or all of the following steps.
Step 1. Collect Cost Information
This information typically comes from the general ledger for actual costs, but the information can also be compiled through an activity-based costing system or some less formal collection methodology. Projected costs come from comparisons to similar projects or products, or estimates based on projected bills of material.
Step 2. Review for Cost Reduction Opportunities
This step can include the separation of costs into fixed, variable, and mixed costs, reviewing costs on a trend line, analyzing the impact on bottleneck operations, and comparing costs to those of benchmark companies.
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Step 3. Report Results
Report the results of the analysis to management, with recommended actions. This is generally a relatively short report that focuses on the issues found, and noting the resources required to make a fix, along with the change in profits that will occur as a result of the recommended changes.
Step 4. Install Controls
Set up controls to ensure that changes imposed by management are adhered to in the manner intended. These controls may be manual, requiring direct oversight, or they may be automated, where the relevant computer systems are adjusted to ensure that the controls take place automatically.
Step 5. Monitor Changes
Monitor any changes imposed by management as a result of this analysis, to see how the alterations have modified the cost profile of the business. Monitoring may reveal that additional iterations of the cost management process are required. This is most likely to be the case for complex processes, where many issues may be causing costs to spiral out of control.
Characteristics of Cost Management
The primary characteristics of cost management include the following items:
Planning and budgeting. Cost management establishes financial goals and limits for a project or business activity.
Cost estimation. Cost management can be used to predict the total cost of a project or operation. This provides a basis for setting budgets.
Cost monitoring. Cost management ensures that expenses align with the budget throughout the process by identifying deviations from the budget and their causes.
Cost control. Cost management involves taking corrective actions when costs exceed planned levels. This reduces waste, optimizes resource utilization, and avoids unnecessary expenses.
Lifecycle orientation. Cost management considers costs throughout the lifecycle of a project, product, or asset—from inception to completion or disposal. This approach focuses on minimizing total lifecycle costs while maintaining quality.
Performance measurement. Cost management tracks key metrics, such as the cost variance, cost performance index, and return on investment, which are used to refine processes and improve future cost management.
These characteristics make cost management an essential tool for achieving efficiency, profitability, and sustainability in both projects and ongoing business operations.
Cost Management for Future Activities
If a business is trying to manage costs associated with future activities (such as the design of a new product or the construction of a new headquarters building) then the cost management activities are somewhat different. Any of the following activities could be followed:
Use target costing to continually estimate costs as features are added to or subtracted from a project (usually a new product).
Use milestone reviews to compare the costs originally estimated to be incurred to actual costs incurred. These reviews can sometimes result in the outright cancellation of projects prior to their completion.
Cost Management Monitoring Activities
Cost management can also involve a simple monitoring function, where there is no immediate need to make alterations. In this case, the following approaches to cost management can be followed:
Use variance analysis to highlight any differences between incurred costs and budgeted costs.
Use exception analysis to highlight only those variances from budgeted costs that exceed a certain threshold.
Use trend analysis to note long-term changes in certain costs.
In short, cost management is a broad topic that encompasses a variety of data collection, analysis, reporting, and control activities. Every company wanting to remain profitable over the long term will need to spend a considerable proportion of its time attending to cost management activities.