In the business world, taking care of one’s bottom line is fundamental for the pursuit of sustainable profitability, growth, and development. Net income in the form of free cash flow can be used to pay off debt, hire new employees, or simply reinvest in the business.
To keep a healthy balance sheet, it is imperative that revenue remains greater than your actual costs. However, this is easier said than done. According to data published by the US Bureau of Labor, around 10% of startups fail within their first year of operation.
This is where cost control and its associated methods can step in to help. Let’s think of it as financial planning but on an enterprise level. Read on to find out what cost control strategies, measures, and systems exist and how you can take advantage of them to reduce costs and stay competitive.
An introduction to cost control
Cost control is the process of managing expenses in an organization, with the ultimate aim of cutting costs to gain financial stability and hit a target net income. Of course, this should not be carried out to the detriment of your product offerings; a balance needs to be struck. But in general, long-term cost savings are the cornerstone for the success of many companies, no matter their size or industry.
Types of business expenses
The first step in cost control is to understand your financial data and the types of costs your business is shouldering. By identifying all the costs involved, management can then take action to optimize operations and—you guessed it!—reduce costs.
All costs can be grouped into the following 4 categories, the sum of which makes up the total cost of production.
Fixed costs
Fixed costs are constant over a specific period of time. They do not vary according to the amount of goods produced and are usually unrelated to a company’s products and services. Fixed costs can include items such as office rent and insurance premiums.
Variable costs
On the other hand, variable costs can change as a result of business circumstances, for example, the level of output or the number of hours in overtime pay. Variable costs can be more difficult to quantify because they are less predictable and yet have a direct impact on profit margins.
Fixed and variable costs are the main types of costs to a business.
Direct costs
Direct costs are the costs associated with producing a product or service. This includes items such as packaging, labor, and logistics. These are easy to monitor and keep track of because they can be traced to specific project items.
Indirect costs
These are project expenses that are unrelated to production processes. Unlike direct costs, indirect costs are more nebulous and cannot be traced so easily. For instance, they can include the cost of security upkeep in the building where your business is operating.
The differences between cost control and cost management
Although cost control and cost management might sound interchangeable, they are in fact discrete terms that need to be defined and understood separately.
As previously mentioned, cost control concerns itself with identifying which actual costs run higher than your budgeted cost—a phenomenon that is also known as cost variance—and taking corrective action to minimize these cost overruns.
In contrast, cost management takes a bird’s-eye view of a project and estimates the financial resources needed to see this to completion. While cost management is a continuous process, cost control takes place at scheduled intervals or when deemed necessary. In fact, cost control can be said to be a part of larger cost management practices.
Why is cost control important in ensuring a thriving business?
Simply put, cost control not only helps businesses stay profitable, but it also actively tries to maximize these gains by lowering actual costs without compromising quality. Consequently, it is more likely that you’ll end up following your project’s budget and timeline, resulting in happy customers who will speak highly of your business to others. All these aspects will create positive cash flows and growth momentum for your company going forward. What’s not to like?
Five cost control methods
Now that you understand the importance and basics of cost control, let’s discuss the 5 main cost control models that companies use to track, correct, and optimize costs.
Method #1: Plan your project budget
The first step to effective cost control is determining project budget, otherwise known as resource planning. This is the process of identifying the resources needed for the task(s) at hand, for example, labor, materials, and length of time.
If this sounds overwhelming to you, it doesn’t have to be. Break every deliverable down into subtasks and decide the number of people, type of skill sets, and equipment needed to complete each of them. Leave room for contingency planning, as you will likely come up against unexpected costs along the way. There is always a chance that a task will take longer than anticipated—or that more material will be used than initially expected—so it is a good idea to build in some breathing space to accommodate potential unforeseen events.
Method #2: Implement good time management strategies
As the well-worn saying goes: Time is money. This makes time management a crucial cost control method. If a project extends past its deadline, it will inevitably cause expenses to rise because labor costs are closely tied to man-hours. This is also an opportunity cost because the workers involved will not be able to start on new projects.
According to research from Zippia, 82% of people don’t have a time management system, leading to the average worker spending 51% of each workday on low- to no-value tasks. The good news is this is an easy fix. There are a plethora of time management systems out there, such as the Pomodoro technique, timeboxing, the Kanban system, and the iceberg method, among many others. Dedicate some time to trialing a few of these options to see which one works best for you and your employees.
Method #3: Use change control systems
Change control systems refer to a project management methodology. It manages all change requests that might arise during the course of a project. When a change request is received, the person or team in charge will evaluate it before deciding to accept, reject, or defer it. The aim is to ensure only necessary changes are made, cost variances are avoided, and the project continues to proceed as smoothly as possible.
Method #4: Regularly monitor project costs
Monitoring project expenses is another frequently used cost control technique. It involves a business’s financial management scheduling checkpoints at regular intervals (usually on a weekly or monthly basis) to review and ensure that the project schedule is on track and the actual cost is closely following the budgeted cost.
These professionals can also decide if changes need to or can be made based on the financial data they have at hand. The objective is to ensure that the changes made do not have a meaningful impact on the agreed budget.
Method #5: Deploy earned value management
Earned value management (EVM) is a popular cost control approach among accountants and project managers, as it is an objective means of measuring project and cost performance. EVM is based on an influential study by Quentin Fleming and Joel Koppelman, which showed that when a project is 20% complete, current project performance can be used to predict the final financial outcome with a deviation of plus or minus 10%.
To determine earned value, multiply the budgeted cost of work completed against the total project budget. For example, if your project is 50% complete and the task budget is $100,000, then the earned value of the project so far is $50,000. Based on this calculation, the project manager will know if the project is behind or ahead of schedule and if it is over or under budget.
This powerful predictive tool allows for changes to be made in advance to keep a project and its budget on course, making it one of the best cost control techniques out there. EVM is normally calculated in spreadsheets and requires some cost accounting knowledge, which we will cover shortly.
Techniques for effective project cost control
There are other techniques to consider in the quest for the best cost control methods for your business.
Implement cost accounting
Cost accounting aims to pinpoint a company’s total cost of production. The latter is determined by adding up the cost of each business operation with fixed costs. Not only do you get a cost estimation out of this, but it will also help you recognize areas where efficiency can be improved.
Deploy an enterprise resource planning (ERP) cost control system
Enterprise resource planning (ERP) is a system that automates business processes while providing key project insights. With ERP, project data sets are integrated into a central database that can churn out real-time, actionable insights to keep operations lean and efficient. ERP can take over low-value and manual functions, freeing your employees to focus on value-adding activities. By automating tasks such as order processing, you might even find that deals can close faster.
Negotiate with your suppliers and vendors
Most businesses have external suppliers and vendors. Before deciding on your contractors, make sure you get quotes from multiple sources to ensure you are getting the best deal. Once you lock in these suppliers, make it clear that you are interested in working with them long term to secure the most favorable terms possible, such as bulk purchase discounts. Lower procurement costs directly correlate to lower actual expenditures.
Consider using project management software
Let’s face it: Cost control can be a tedious and time-consuming process. At the same time, it is indispensable if you want to ensure business profitability. Luckily, there are now many project cost management tools that can automate and streamline these processes. Here are a few examples:
- Harvest: One of the oldest project management software tools out there, Harvest helps businesses with time tracking, budget management, and invoicing. However, given its primary focus in these areas, the tool does not provide much in terms of project planning and scheduling.
- monday.com: This software system allows for workflow customization, which helps align cost control with specific project requirements. There is also a focus on group collaboration through file sharing, chat, and real-time update capabilities.
- Wrike: Designed to track the time of remote employees, Wrike features Kanban boards, Gantt charts, and other workload charts. Project budgeting and performance tracking features are also integrated. One potential downside of Wrike is its complexity, as it can take time to get fully onboarded, even if you are not a beginner in project management software.
- Toggl Track: Toggl Track has time-tracking capabilities within an intuitive interface, with some project management features. Like Harvest, it has a focus on a certain area—in this case time tracking—and limited project management functionality. However, it’s possible to integrate Toggl Track with other project management tools.
Identify areas where processes can be streamlined
Racing cars have a streamlined shape in order to reduce friction and attain high speeds. The same principle applies to cost control. In order to deliver more quickly and at a better cost performance, take the time to identify and eliminate all superfluous steps, processes, and materials. And, as previously mentioned, consider introducing automation such as project management software. This will further reduce business expenses in the form of labor and time.
Review your pricing strategies
Setting competitive prices is key to business success. When making these decisions, take project cost, market demand, and competitors’ prices into account. If your product offers unique features or is of higher quality, ensure that this is reflected in its final price. Once your product is in the market, use data collection tools such as customer polls and surveys to check users’ price perception of your brand. Finally, don’t adopt a set-it-and-forget-it attitude to prices; regularly review and adjust these to secure your long-term profitability.
Common cost control challenges
While the benefits of cost control strategies and methods are widely known, companies often find it difficult to ensure their proper implementation. If it were that easy, every company would be, in theory, profitable. The following are the most common obstacles to effective cost control and overall project success.
Merging data from too many different sources
Financial data can come from a variety of sources, such as different subcontractors and content management systems (CMSs). It isn’t easy to come up with a system that can unify these multiple data streams in a coherent and usable manner. This makes it more difficult to pinpoint the areas where costs can be reduced and processes streamlined.
Having flawed reports
Cost control is based on reporting and data. However, mistakes are very common in these documents. The error rate in average manual data entry is 1%, a number that goes up if the data being entered is complicated, the data transcriber is fatigued, or the handwriting is simply difficult to decipher. In 2021, one spreadsheet blunder cost a company to lose a whopping $10.5M. All this underscores how every error can impact the accuracy of cost control systems and measures taken to minimize cost overruns.
Ensuring cost control itself does not become too costly
As just mentioned, cost control can be an error-prone and protracted process. It relies heavily on data compilation and reporting, which in itself is very time-consuming and thus, pricey. However, it’s challenging to put time constraints on cost control processes given how success hinges on thoroughness and accuracy.
Confusing cost control with cost accounting
Cost accounting deals with the recording, analyzing, and reporting of company costs, whereas cost control is more strategic and focuses on decreasing the total costs of production. Cost accounting in itself is not enough to keep cost variance low, so be sure to implement it alongside cost control.
Forcing buy-in from everyone involved in the cost control process
Continuous collaboration and consistent communication between stakeholders are key to creating successful cost control processes. However, the sheer number of parties that can be involved in any one project might make this a difficult obstacle to overcome.
Not adopting new systems and technologies
Many businesses choose to stick with legacy systems and technologies, despite advancements in project management and cost control software. Companies that don’t take advantage of these technological advancements will inevitably be left behind, and yet a majority of businesses still tend to stick with what they know.
For example, spreadsheets were created in the 1980s and will not be able to keep up with applications driven by big data and artificial intelligence. In order to be useful, spreadsheets require correct entry of data and formula. And, as we have previously seen, spreadsheets are error prone. Contrast this to an AI tool, where the math is coded into the system to ensure accurate results.
Set the stage for reduced actual costs and improved profit margins
It is worth investing the time to understand cost control at a fundamental level. If you can adopt it at an early stage, use the methods and software that are best suited to your business, and ensure stakeholder buy-in, you will be well on your way to better profit margins and sustained competitive advantage. The sky’s your limit, good luck!