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What Is Cost Control?
Cost control is the practice of identifying and reducing business expenses to increase profits, and it starts with the budgeting process. A business owner checks the company’s actual financial results against the budget. If costs are higher than planned, management can take action.
For example, a company can request bids from different vendors offering the same product or service to lower costs. Cost control helps maintain and grow profitability.
For example, companies often outsource payroll. This is because payroll tax laws change often and employee turnover requires frequent records updates. A payroll company can calculate the net pay and tax withholdings for each worker, which saves the employer time and expense.
Key Takeaways
- Cost control starts with the budgeting process and involves identifying and reducing business expenses to increase profits.
- Outsourcing tasks such as payroll is a common cost control method that can save companies time and money.
- Fixed costs are more challenging to reduce than variable costs, and examples include rent and insurance payments.
- Variance analysis helps businesses compare budgeted costs to actual costs, enabling management to address significant discrepancies.
- Households can implement cost control strategies by budgeting, comparing prices, and shopping during sales to enhance savings.
Investopedia / Jiaqi Zhou
How Cost Controls Contribute to Profitability
Controlling costs is one way to plan for a target net income, which is computed using the following formula:
Sales – fixed costs – variable costs = target net income
Assume, for example, that a retail clothing shop wants to earn $10,000 in net income from $100,000 in sales for the month. To reach the goal, management reviews both fixed and variable costs and attempts to reduce the expenses. Inventory is a variable cost that can be reduced by finding other suppliers that may offer more competitive prices.
It may take longer to reduce fixed costs, such as a lease payment, because these costs are usually fixed in a contract. Reaching a target net income is particularly important for a public company, since investors purchase the issuer’s common stock based on the expectation of earnings growth over time.
Important
Outsourcing is used frequently to control costs because many businesses find it cheaper to pay a third party to perform a task than to take on the work within the company.
Implementing Variance Analysis for Effective Cost Control
A variance is the difference between budgeted and actual results. Managers use variance analysis to pinpoint areas needing change. Companies should analyze variances in all revenue and expense accounts monthly. Management should focus first on accounts with the largest dollar variances, as these impact results the most.
For example, if a toy manufacturer has a $50,000 unfavorable variance in material expenses, the firm should consider getting bids from other suppliers to lower costs and eliminate the variance. Some businesses analyze variances and take action on the actual costs that have the largest percentage difference from budgeted costs.
Why Is Cost Control Important for Businesses?
In a competitive marketplace, the low-cost producers are the ones that can earn the highest profits. Reducing costs is therefore a key objective for most businesses since it increases both efficiency and profitability.
What Types of Costs do Businesses Incur?
In general, business costs can be categorized as fixed vs. variable and direct vs. indirect.
- Fixed costs are those that do not change, such as rent or insurance payments.
- Variable costs will change with productivity such as wage labor or energy usage.
- Direct costs are those involved with production or operations, such as costs of raw materials.
- Indirect costs include things like overhead, which are not directly related to the business’s core operations.
How Can Households Implement Cost Controls?
Cost controls are often associated with increasing the operating efficiency of a business; however, individuals and households can also benefit from such strategies to increase savings and cash flows. Establishing and sticking to a budget is one key strategy. Shopping around and comparing competitors’ prices is another way to keep prices down. Look to shop when items are on sale and consider second-hand goods if possible.
The Bottom Line
This updated section provides a concise and active summary of the article, emphasizing the significance of cost control in business and personal finance. It highlights the key points discussed—budgeting, cost monitoring, outsourcing, and variance analysis—while offering actionable takeaways for both businesses and individuals. This aligns with Investopedia’s mission to simplify complex information and empower readers with practical knowledge.
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