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Cost management purpose

Category: Financial Control Management

Cost Management means (1) knowledge of where, when and what company resources are used, (2) forecast of where, for what and what amount of additional financial resources are necessary, and (3) ability to ensure the highest possible efficiency level of resource use. Cost Management is the ability to save resources and maximize their efficiency.

Cost Management consists of:

— Having a systematic approach to determining what your real costs are;

— Understanding why costs are incurred;

— Taking action based on your analysis and understanding, in order to improve the company’s cost structure (cost reduction, strategic choices);

— Always looking for opportunities to save money.

Advantages of effective Cost Management:

— More cost competitive products, and thus increased sales opportunities;

— Appropriately priced products and flexibility in pricing;

— Availability of qualitative and real information about the cost of certain types of products and their position in the market in comparison with the other competitors’ products;

— Better resources allocation and a better managed business;

— Providing objective data for generating company budgets;

— Capability of evaluating performance of each division in the enterprise from the financial point of view;

While understanding the true costs the company has the opportunity to take better management decisions. The appropriate management of costs will lead to a more competitive enterprise.

The consequences of inefficient Cost Management are:

— Cash is wasted;

— Product prices are set incorrectly;

— Resources are dedicated to «wrong» products, activities or customers;

— Management does not know how the company can reduce its costs;

— Costs rise without being noticed because they are not managed;

— Profitability drops for unknown reasons.

The answer to the question: “How could the production strategy from a cost point of view be optimized in such a way that it would contribute to an appropriate pricing of products and to selling them in a profitable way” could be found through the comparison of the Costing Models.

Full Absorption Costing Model — is based on the calculation of the product cost by applying the total cost incurred for the company or for a particular production line to the total range of products. This model was widely used in countries with controlled economy. It does not provide an accurate or sensitive measurement framework for price computation in competitive markets, and does not provide a basis for determining which products are making profits and which are causing losses. In competitive markets, those companies that can cut their Per Unit Production Costs to a minimum are going to be able to sell their products at a lower price. Those companies that cannot cut their costs will lose market share or suffer losses.

Avoidable Costing Model. It is used by some western companies. It involves selecting of some of the overhead costs and attributing them to a particular product. Avoidable Costs are those overhead costs that would be eliminated if a particular product was completely withdrawn from the production. This method provide a more accurate assessment of the cost of producing a product than the Full Absorption Method, but still does not accurately measures the costs involved for that product.

Variable Costing Model. It is also called the «Marginal Costing Model’, that provides an accurate measure of the costs involved in producing a unit of a particular product. It is the model used most widely in the West, nevertheless in the last years this model is getting more popularity among former SU countries.

Variable Costing Model identifies the costs of producing each additional unit for a given product and focuses on how product costs change when the volume of production changes. It entails identifying which costs are directly attributable to a product (variable costs), e.g., the raw material costs and energy costs. Once these variable per unit costs are known, by subtracting them from the price of the product, one can determine how much of the price is available to cover overhead costs. This amount that contributes to covering fixed costs is called Contribution.

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