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STRATEGIC COST MANAGEMENT

Anil B Malali
Cost Management:
Cost Management Defined:
The Purchasing Handbook defines cost management as, "the establishment of programs that
regularly analyze purchase requirements and suppliers to identify lowest total cost and
maximize total value to the company. The development of a savings forecast by commodity is
necessary to define budget parameters for building cost-of-goods structures."
Importance of Analyzing and managing costs:
Cost analysis is an important component of all economic evaluation techniques. It is a useful tool for
planning and self-assessment. Cost analysis is particularly useful for the following purposes:
1.
2.
3.
4.
5.
6.

Determine Costs
Ascertainment of Profit
Operating efficiency
Formulation of pricing policies
Cost reduction and control
Link corporate strategies

Objectives of Cost Management


The main objective of cost management is to reduce the costs expended by an organization while
strengthening the strategic position of the firm. Three ways to institute cost management techniques
are as follows:

1. Establish systems to help streamline the transactions between corporate support departments
and the operating units.
2. Devise transfer pricing systems to coordinate the buyer-supplier interactions between
decentralized organizational operating units

3. Use pseudo profit centers to create profit maximizing behavior in what were formerly cost
centers.
These cost management systems will not only manage costs, but also enhance profit consciousness.
This will help the organizations ability to serve its customers because divisions will become
increasingly more focused on operating more efficiently.
Areas of Cost Management:
1. Resource Planning for Cost Management
Resource planning determines what physical resources (i.e., people, equipment, and materials) are
needed to complete a project. It is directly related to cost management because all of those elements
cost the organization something, whether it be in terms of monetary funds or time. The resources
needed for a project to be completed must be evaluated to assess the value the organization will get
from taking a project on or changing its current methods to make it a more efficient organization.
2. Cost Estimating
Summary of the cost assessments of the resources required to complete projects. Costs must be
predicted for ALL resources and are generally expressed in currency terms to compare among
projects. Other units may be used such as hours or days to describe various resources. Cost estimates
may be refined throughout the project. In general, cost estimating is the prediction of teh amount of
cost an organization will have to expend to complete a project.
3. Cost Budgeting
Cost budgeting involves allocating cost estimates to specific accounts within the organization to
establish a baseline

4. Cost control

Cost control defines the procedures by which the baseline may be changed and integrated. It includes
the paperwork, tracking systems, and approval levels for authorization
Tools and Techniques of Cost Management
The various tools and techniques of Cost Management are:
1. Target Costing- Target costing is a pricing method used by firms. It is defined as "a cost
management tool for reducing the overall cost of a product over its entire life-cycle with the
help of production, engineering, research and design"
2. Activity Based Costing- Activity-based costing (ABC) is a costing methodology that
identifies activities in an organization and assigns the cost of each activity with resources to all
products and services according to the actual consumption by each. This model assigns more
indirect costs (overhead) into direct costs compared to conventional costing.

3. Just in Time- Just-in-time (JIT) manufacturing is a production model in which items are
created to meet demand, not created in surplus or in advance of need. The purpose of JIT
production is to avoid the waste associated with overproduction, waiting and excess inventory,
three of the seven waste categories defined in the Toyota Production System.

4. TQM- TQM is an integrative philosophy of management for continuously improving the


quality of products and processes.
TQM is based on the premise that the quality of products and processes is the responsibility of
everyone involved with the creation or consumption of the products or services which are
offered by an organization, requiring the involvement of management, workforce, suppliers,
and customers, to meet or exceed customer expectations.

5. Benchmarking- Benchmarking is the process of comparing one's business processes and


performance metrics to industry bests or best practices from other industries. Dimensions
typically measured are quality, time and cost.

6. Balanced Score Card- The balanced scorecard (BSC) is a strategy performance management
tool - a semi-standard structured report, supported by design methods and automation tools,
that can be used by managers to keep track of the execution of activities by the staff within
their control and to monitor the consequences arising from these actions.

7. Life Cycle Costing- Life cycle costing is a method of economic analysis for all costs related to
building, operating, and maintaining a project over a defined period of time. Assumed
escalation rates are used to account for increases in utility costs over time. Future costs are
expressed in present day dollars by applying a discount rate. All costs and savings can then be
directly compared and fully-informed decisions can be made.
8. Value Analysis- VA can be defined as a systematic review that is applied to existing product
design in order to compare the function of the product required by the customer to meet their
requirements at the lowest cost, consistent with the specified performance needed.

Role of Cost Accounting in strategic planning and control:


Cost accounting provides vital information to help management take crucial decisions. Some of the
major areas are1.

Functional Restructuring

2. Change Agent
3. Using Value Chain Analysis to integrate costing and strategies

4. Best use of Resources


5. Price determination
6. Cost Control and Reduction

Difference between Cost Accounting and Cost Management


Cost Accounting

Cost Management

1. Recording & analysis activity

Managerial Activity

2. Gives inputs to Cost Management

Broader Concept

3. Focus on Cost containment

Focus is on Customer Satisfaction

Cost Management System:


Cost Management System is a set of Formal methods developed for planning and controlling
organizational costs to achieve profitability in the short run and competitive advantage in the long run.

6 Primary Goals
1. Accurate product costs
2. Assess P&L cycle performance
3. Improve processes

4. Control cost
5. Measure performance
6. Allow the pursuit of organizational strategies

Factors to be considered in designing Cost Management system:

1. Type of Organization, Product and culture


2. Organizational Mission
3. Available core competency
4. Competitors