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Cost control that produces cost savings is an essential tool in financial management to reduce business and project expenses through cost accounting, budgetary control, financial statement analysis, and project management tools.
Cost control and vendor management often go hand-in-hand, since optimizing how you interact with vendors can produce significant cost savings for your business. And expense management automation helps your company achieve savings through cost control.
What is Cost Control?
Cost control is the process of identifying, eliminating or reducing unnecessary business expenses in order to increase profits. Cost control starts with the budgeting process and looks at vendor selection and negotiation, leveraging early payment and volume discounts, using spend management systems, and improving manufacturing or construction efficiency and product quality.
Cost Control as a Part of Cost Management
The goal of cost control is to give your company a powerful framework that’s designed to improve visibility and keep you in control of your costs.
Cost control reduces costs and expenses by managing budget vs. actual variances by cost center, profit center, department, or project and taking corrective action. Cost control is one step in the cost management process.
Cost management is a broader term, encompassing estimating methods to forecast resources required and perform cost estimation, budgeting, cash flow forecasting, funding the budget, controlling costs, and performing a post-project evaluation for future cost-saving opportunities. The cost accounting function in a business contributes to the cost management process.
Steps of Cost Management
Steps of cost management include:
- Resource planning
- Cost estimating
- Cost budgeting
- Cost control
- Post-project cost evaluation
Cost Management in Project Management Cost
Project management cost needs monitoring and attention during the project activities phase before completion. Specialized project management software and metrics should be used to estimate cost baseline by task, control, and reduce project costs in a cost control system. Post-project analysis can make future projects more efficient through a learning curve.
Cost Estimation Techniques to Consider
Estimation as an important step in managing costs. Let’s dig deeper by talking about some exact techniques for making accurate estimates, especially since budgeting for complex workflows can be a challenge.
Factor Estimation
Projects are almost never fully “figured out” when they begin. The scope might not be fully defined, and certain features may still need some work. It would be a waste of time to form a detailed budgetary analysis now since it would likely change quickly.
The factor estimation method is the fastest way to get a general overview of what to expect. The industrial sector is familiar with one convenient trick known as the sixth-tenths rule, where the expected cost goes up by six-tenths as the size of the manufacturing facility increases.
Parametric Estimation
Past financial data is an invaluable tool for accurately predicting new expenses. Parametric methods involve analyzing previous contract prices and values and finding out the relationships between materials and labor in previous works.
For instance, you might notice that the thickness of the sheets of metal used in an engineering project consistently correlates to higher costs. Think about ways you can use that information the next time a similar project begins.
Quantitative Factor
As the workload progresses, you will slowly gain more insight and have a clearer picture in your mind of how it will finish. The quantitative factor estimation builds on the “factor estimation” step from earlier by attaching empirical data you gain during project execution to figure out more precise estimations.
Resource-Based Estimation
The resource-based technique is an option if time is considered a sensitive asset. Here, the team will estimate and manage the amount of time it takes to complete a certain portion of the work and schedule it to a calendar. Keeping the duration of the workload under control can be just as important as keeping monetary costs low.
Unit-Rate
It may seem obvious, but simply extrapolating the entire cost by using a smaller unit of cost as a benchmark is an effective method. For instance, a short pipe might cost $15 and require an hour of installation time. If you’re using 20 of these pipes, you can expect the cost to be around $300 and 20 hours of work.
While not always accurate (installation time may be shorter the more units you install at a time, for example), unit-rate will always be a tool on the table of any cost engineer.
Control Methods
Control methods used for expense and cost management include target net income, variance analysis, and earned value management. Control methods also include using specialized cost management software for the business and project management to improve cost budgeting and cost performance.
Target Net Income
Target net income is the expected amount of business profits after taxes for an accounting period. Target net income is used to determine an appropriate level of expenses and costs in a budget to produce the desired income level for a business or project.
Target net income can be used in the breakeven analysis formula to determine the number of units required to meet the target net income instead of using a zero breakeven amount. The difference between sales and variable costs (sales – variable costs) is called the contribution margin.
The formula for target net income is:
Target net income = sales – variable costs – fixed costs
where,
Target net income = (units x sales price) – (units x variable cost) – fixed costs
You can use these formulas by supplying the target net income amount to solve for either units or sales dollars required to reach the target net income. Or you can solve for target net income if you have forecasted the other variables.
Variance Analysis
Variance analysis compares budget and actual amounts for accounting categories for a time period or project. Unfavorable variances occur when actual costs exceed budget amounts. Favorable variances represent actual costs below budget, indicating better actual results than expected.
Cost accounting systems with standard costs (often used by manufacturing companies) are useful for variance analysis of actual costs vs. standard costs for labor, materials, and overhead.
Each month and at year-end or project closing, financial analysts drill down to the data source of significant unfavorable variances to identify causes and correct overspending through future cost or expense reductions.
Earned Value Management
Earned value management (EVM) controls projects as they progress, including the schedule and actual costs vs planned costs. The planned project costs expected for the percentage of completion of the project to date are compared to actual costs incurred on the project to date to establish project controls and evaluate project performance.
Earned value management provides an opportunity to use cost control on a project while it’s in progress by monitoring whether cost overruns occur. When managers reduce project expenses in response to EVM metrics, project management results will improve. If cost variances are excessive and cancellation is feasible, a business may decide to terminate an unprofitable project before completion.
Examples of Cost Control
Examples of types of cost control include:
- Renegotiating contracts with more favorable terms
- Getting more competitive bids from different vendors
- Improving product quality to reduce rework and scrap
- Reducing the number of items carried in inventory
- Reducing employee expenses with better expense management
- Accounts payable outsourcing
- Increasing efficiency with automation software
- Taking early payment discounts on accounts payable
How can your business improve cost control?
Download our white paper, “The Holy Grail of Accounts Payable” to learn how your business can better control its accounts payable-related costs.
Common Challenges of Cost Control
Even experienced companies occasionally have missteps during cost control operations. It’s worth going over a few pitfalls and challenges to the process as well. They include:
- Mistaking cost analysis with accounting: Accounting deals mainly with just counting up the costs among other tasks, whereas cost control goes deep into a project and plans out the funding.
- Consistently analyzing budget and predictions: Calculating the budget and predicting cost control is often performed by separate employees, resulting in inconsistent analyses that could compromise the reliability of the results.
- Aligning data from multiple sources: Relevant financial data can come from a variety of subcontractors and content management systems. It takes a degree of organization and skill to ensure all this data is usable.
- Aligning time and money: In the same vein, there’s a discrepancy between project schedulers who schedule the workload according to activities and tasks and cost analysts who use transactions and fiscal periods. Making these two sources comparable is another challenge of cost control.
- Accommodating project changes: As a project goes along, the scope, features, or goals may change over time. How does cost control, which relies on predicting future expenses, work around this challenge?
- Controlling the cost of cost control itself: It can be time-consuming and error-prone to perform cost control, from the data collection to the analysis to executing the corrective actions. What results is another form of cost to consider.
Regardless of the setbacks, a well thought-out cost control system can set an organization up for success. Standardizing the process and giving the company flexibility is the best way to deal with complicated or changing projects.
Investing in technology is one of the best steps to take to boost the chances of project success and minimize risks.
Cost Control Software
Cost control software, which often includes dashboards for spend management and spend analysis, is available as a management system for different business applications.
Core ERP and Accounting Software
ERP (enterprise resource planning) and accounting systems have built-in actual vs. budget comparisons for detailed financial statements by account, with drill-down to underlying data. These budget variance features are essential for cost control.
Standard vs. actual costing can be implemented in feature-rich ERP systems for manufacturing companies. Standard costing variances include labor hours, labor pricing, material purchase price, material usage, and overhead spending and overhead usage variances due to changes in production volume or machine hours.
Financial Forecasting and Budgeting Software
Fully-featured business forecasting and budgeting software may be offered as an ERP software module or a stand-alone software product. Advanced financial forecasting and budgeting software will generate a more accurate sales forecast and cost budget for cost control variance analysis.
Smart Shop Floor Modules
Cost control software includes specialized features within ERP systems for a smart shop floor application using IoT sensors (Internet of Things), machine learning, and artificial intelligence software.
These applications initiate real-time alert notifications when manufacturing processes deviate from standards to trigger exceptions. Generally, the sooner the alert is issued, the less scrap and rework costs a manufacturer experiences.
AP Automation Software
Accounts payable automation software integrates with ERP and accounting systems to streamline and reduce the payables and global mass payments workload by up to 80%, reducing future labor costs for new hires.
AP automation software provides:
- Self-service supplier onboarding and tax reporting via a portal
- Electronic invoice capture with OCR or uploading
- Matching invoices with purchase orders and receiving reports
- Global regulatory compliance
- Duplicate payments and fraud prevention screening
- Automated approval routing
- Global mass payments using multiple payment methods and currencies
- Invoice payment status notifications to vendors in real-time
- Automated payments reconciliation
Expense Management and Tail Spend Software
Expense management software streamlines employee expense reporting and payment. Travel-management software that may be included in expense management software helps companies track and control travel-related spending. Specialized tail spend software can be used to control employee-initiated routine spending on low-cost items outside the procurement department.
Project Management Software
Project management software includes project costing, estimating the project schedule, resource estimation, resource costing and budgeting, Gannt charts, and variance analysis. The software should help you perform a post-project evaluation of actual expenditures resulting in total cost vs. budget and benchmarks with similar projects and competitors.
Earned value management, cost management steps, and target net income for a project may be incorporated into project management software.
FAQs
What Are the Benefits of Cost Control?
How Do You Control Costs?
Companies control costs by examining current processes and resources to determine actual budgets, exploring where costs can be cut, and monitoring cost variance.
What is the Difference Between Cost Control and Cost Management?
The difference between cost control and cost management is that cost control is the process of analyzing and adjusting spending activity to control spending and costs, while cost management involves the tracking and understanding of financial activities so that potential changes can later be made.
The Importance of Cost Control
Cost control has importance because it lets businesses reduce costs and expenses during the year through analysis and monitoring variances at each budget control level. Managers are accountable for results. Companies that control costs well through optimization practices and cost control tools have a competitive advantage.
Cost control in project management is essential for an activity in which cost overruns could easily occur.
Costs can be reduced through cost control strategies, measures, and systems. Cost control will improve business performance data metrics and increase profits, cash flows, and return on investments (ROI). Engagement by team members improves as their ability to make meaningful contributions to results increases.
Investor stakeholders may be attracted to the stock of publicly-traded companies with effective expense control and corporate governance. Lenders will have an increased likelihood of approving debt and loan financing. Successful companies attract the best talent.
Predictability of costs and results increases. Vendor management improves with better procurement and vendor invoice payments with early payment discounts. Project success increases with project budget control. With strategic cost control and action steps, businesses reduce the need for unexpected financing and improve liquidity. To learn more about cost control, download our eBook,“The Ultimate Accounts Payable Survival Guide.”
