cost reduction and cost control
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DESCRIPTIONCOST REDUCTION AND COST CONTROL. CONQUER YOUR COSTS. BEFORE THEY CONQUER YOU. P.RAJU IYER. COST REDUCTION. Cost reduction refers to the real and permanent reduction in the unit cost of the goods manufactured or services rendered. - PowerPoint PPT Presentation
Cost reduction refers to the real and permanent reduction in the unit cost of the goods manufactured or services rendered. COST REDUCTION CAN BE EFFECTED BY EITHER OF THE FOLLOWING WAYS:By reduction in unit cost of production: This is usually brought by elimination of wasteful and non-essential elements in the design of products and from techniques and practices carried out. (Any reduction in costs due to changes in Government policy like reduction in taxes or duties or due to price agreements do not come into the area of cost reduction as these are not real and permanent reductions in costs).
(ii) By increasing productivity: This refers to increase in the volume of output with the expenditure remaining the same. But this should not be achieved at the cost of the characteristics and quality of the product.AREAS OF COST REDUCTION: 1. Design 2. Factory organisation and method 3. Product planning 4. Factory layout and equipment 5. Utility services 6. Marketing 7. Finance
Cost control is concerned with keeping the expenditure within acceptable limits. Its major assumption is that costs are in control unless costs exceed budget or standard by an excessive amount.DIFFERENCES BETWEEN- COST CONTROL COST REDUCTION1. Controls costs towards Represents real and permanent achievement of predetermined decrease in costs. target or goals.2. It is a routine exercise. It is a planned process.3. It is a preventive function. It is a corrective function.
COST CONTROL IS EFFECTED THROUGH BUDGETING & STANDARD COSTINGBudgeting: A budget may be defined as a comprehensive and coordinated plan of action, expressed in monetary terms. It is prepared and approved prior to the budget period and may show income, expenditure and capital to be employed to attain the objective.Standard costing: In this, standards are set and actuals are compared with the standard. Corrective measures are undertaken for any discrepancy found between the standard and actuals.
TECHNIQUES OF COST REDUCTION 1. VALUE ANALYSIS: Value analysis is the identification of unnecessary cost i.e. cost that neither provides quality, nor use, nor life, nor appearance, nor customer satisfaction. Thus value analysis attacks costs at production stage. 2. ECONOMIC BATCH QUANTITY: (EBQ) EBQ is that point where carrying costs equals set up cost approximately. At this point the total cost will also be minimum. 3. ECONOMIC ORDER QUANTITY: (EOQ) EOQ is the quantity fixed at a point where total cost of ordering and the cost of carrying the inventory will be minimum.
ILLUSTRATION: A publishing house purchases 2000 units of a particular item per year at a unit cost of Rs.20/-. The ordering cost per order is Rs.50/- and the inventory carrying cost is 25%. Find the optimal order quantity and the minimal total cost including purchase cost. If 3% discount is offered by the supplier for purchase in lots of 1000 or more, should the publishing house accept the offer? SOLUTION:Optimal order quantity or EOQ = 2 x annual consumption x ordering cost per order inventory carrying cost per unit
2 x 2000units x Rs.50 Rs.20 x 0.25 = 200units.CALCULATION OF MINIMUM TOTAL COST WITHOUT DISCOUNT:No. of orders to be placed for getting 2000units = 10ordersAverage inventory (200units / 2) = 100 unitsPurchase price of 2000units @ Rs.20/unit = Rs.40000Ordering cost (10orders @ Rs.50/order) = Rs. 500Carrying cost for 100uts (avg. inventory) (Rs.20*0.25) = Rs. 500 TOTAL COST = Rs.41000
CALCULATION OF TOTAL COST WITH 3% DISCOUNT WHEN PURCHASE ORDER QUANTITY IS 1000 UNITS:Unit cost after 3% discount (Rs.20 3% of Rs.20) = Rs.19.40Lot size = 1000 utsNo. of orders for 2000units @ 1000units / order = 2 ordersAvg. inventory (1000 uts per order / 2) = 500 utsPurchase cost for 2000 uts @ Rs.19.40/ut. = Rs.38800Ordering cost for 2 orders at Rs.50/order = Rs. 100Carrying cost for avg. inventory (500 * 19.40 * 0.25) = Rs. 2425 TOTAL COST = Rs.41325
The above computation shows that suppliers offer of 3% discount should NOT BE ACCEPTED because it will INCREASE COST by Rs.325/- as compared to the EOQ of 200 units. Counter offer of higher discount should be made if the cost is to be less than Rs.41000/-.
4. ACTIVITY BASED COST MANAGEMENT: ABC assumes that resource-consuming activities cause costs. Its aim is to directly control the activities that cause costs, rather than cost. By managing activities that cause costs, costs will be managed in the long run.Cost causing activities designing, engineering, manufacturing, marketing, etc.
A CASE STUDY IN ABC: Under ABC in a direct mail printing firm, cost reduction occurred by developing plans to eliminate idle time and reduce the total set-up time rather than layoff employees. The firm was reporting decreasing profit although operating at capacity. Its short-run solution was to reduce the labour force, which is a cost the company can control in short run. A study of activities in the printing process, however, indicated a set-up time of 35 hours on complex orders with employees being idle 25% of the time during set-up. ABC demonstrated that this idle time was costing the firm approximately US$.41000 in wages per complex order.
5. JUST-IN-TIME APPROACH: (JIT) The aims of JIT are to produce the required items, at the required quality and in the required quantities, at the precise time they are required. JIT helps in cost reduction by a. elimination of non-value-added activities, b. zero inventory, c. zero defects, d. zero breakdowns, e. single batch ordering. Though the above goals are unlikely to be achieved, it represent targets and create a climate for continuous improvement and excellence.
6. TOTAL QUALITY MANAGEMENT: (TQM) TQM works on the philosophy that all business functions are involved in a process of continuous quality improvement. TQM reduces cost by producing the products correctly the first time rather than wasting resources making substandard items and incurring additional expenditure on inspection, rework and scrapping. It helps organisations to achieve their quality goals by providing reports and measures that will improve quality. TQM aims at a customer-oriented process of continuous improvement that focuses on delivering products or services of consistent high quality in a timely fashion.
7. SUPPLY CHAIN MANAGEMENT: (SCM) SCM attempts to build a cost effective chain beginning with the ultimate customer and links all the previous suppliers under one platform. An effective SCM eliminates most of the activities in between customers and raw material suppliers along with associated costs. Most of the non-core activities are outsourced and hence fixed costs are kept minimal. Close interaction between the corporate R&D and the suppliers facilitates continuous improvements in product design, process methodologies, etc. resulting in customer value enhancement and cost reduction. A rupee spent on the supply chain can give more value than a rupee spent on marketing. The supply chain is part of the service offering.
A CASE STUDY: ESCORTS TRACTORS FARMS BPR resulted to target cost reduction per tractor by 20 %. Introduced in process involving the manufacturers of rear axles, one that required maximum movement of materials across the halls. Pre-reengineering, the manufacture involved 9 changes in ownership, had 21 workers in any given shift, and lead-time of 19 days. Today the process requires only 12 workers per shift, and lead-time has fallen to 8 hours.The physical resources are easy to change. The key to success lies in motivating employees up to the grass root level to initiate change, not just accept it.Farm Tract has extended its efforts to SCM and reduced the number of vendors and brought down the total acquisition cost by 5%.
8. PERT ANALYSIS: Programme Evaluation Review Technique (PERT) reduces cost by giving an optimum schedule for the activities necessary to complete a project. SOME OTHER COST REDUCTION TECHNIQUES ARE 9. Simplification and Standardisation 10. Design analysis 11. Substitute material utilisation 12. Production planning and control 13. Technological forecasting 14. Market research etc.