Strategic cost management

Cost-benefit Analysis

A cost benefit analysis is done to determine how well, or how poorly, a planned action will turn out. Although a cost benefit analysis can be used for almost anything, it is most commonly done on financial questions

A cost benefit analysis finds, quantifies, and adds all the positive factors. These are the benefits. Then it identifies, quantifies, and subtracts all the negatives, the costs. The difference between the two indicates whether the planned action is advisable

Should we hire an additional sales person or assign overtime? Is it a good idea to purchase the new stamping machine? Will we be better off putting our free cash flow into securities rather than investing in additional capital equipment? Each of these questions can be answered by doing a proper cost benefit analysis

Eg-A product manager may compare manufacturing and marketing expenses with projected sales for a proposed product and decide to produce it only if he expects the revenues to eventually recoup the costs


Cost-benefit Analysis is made up of three parts- Technical-Engineering part Context and technical characteristics of the project are identified Defining the socio-economic objectives that the project intends to achieve The technical analysis is carried out to ensure the feasibility of the projected

work from a technical point of view Financial Analysis It provides all the necessary data regarding input, output, their relative prices

and how they are distributed over time Formulate tables for the analysis of the cash flows(selection of the important

cost and revenue items) Evaluate the financial feasibility Evaluate the financial benefit by calculating the return from the private

investor’s point of view(financial return of the project and the capital) Economic Analysis Serves to identify all the income and expenditure items and the relative market

prices


The economic internal rate of return is expected to be higher than the rate of financial return otherwise the the project would be more convenient for a private investor than for a public operator

The calculation of the economic indicators allows for the creation of a ranking of projects and helps in the selection of more than one alternative intervention

Steps in Cost-benefit Analysis Defining objective and project scope Identify and screening the alternatives Identifying the benefits and costs Calculating discounted cash flows and project performance criteria Ranking the alternatives in order of preference Conducting sensitivity analysis Make a final recommendation


Principle of Cost-benefit Analysis All benefits and costs of a project should be measured in terms of their equivalent money

value The net benefit of the projects is the sum of the PV of the benefits less the PV of the costs The valuation of benefits and costs should reflect preferences revealed by choices which

have been made When consumers make purchases at market prices they reveal that the things they buy are

at least as beneficial to them as the money they relinquish The increase in benefits resulting from an increase in consumption is the sum of the

marginal benefit times each incremental increase in consumption When a project is being evaluated the analysis must estimate not only what the situation

would be with the project but also what it would be without the project Double counting of benefits or costs must be avoided. Pg 19 Decision criteria for Projects If the discounted PV of the benefits exceeds the discounted PV of the costs then the

project is worthwhile Ratio of the PV of the benefits to the PV of the costs must be greater than 1 From the set of mutually exclusive projects the one that should be selected is the one

with the highest NPV


Use of Cost-benefit Analysis- Road safety measures Some people find the very idea of assigning a monetary value to lifesaving or to

quality of life, which is an essential element of cost-benefit analysis, meaningless and ethically wrong

The purpose of assigning a monetary value to human life is simply to provide a guideline with respect to the amount of resources we would like to spend on the prevention of accidents or injuries.

A limited amount of resources is at our disposal for the prevention of accidents or injuries, or indeed for catering to any human need

Safety is certainly one of the more basic human needs, it is not the only one, and no society would ever be able to spend more than a fraction of disposable resources on the prevention of accidents or injuries

How much to spend on the prevention of accidents or injuries will depend on how important people think this good is, seen in relation to all other goods they would like to see produced

The objective of cost-benefit analysis is to help us find the right balance between safety and other goods

The main reason for doing cost-benefit analyses of road safety measures is to help develop policies that make the most efficient use of resources. Cost-benefit analysis seeks to identify the cheapest way of improving road safety


Applicability of Cost-benefit Analysis- Road safety measures In general, to be amenable to cost-benefit analysis, a road safety measure should

satisfy the following criteria: It should be known what category of accidents the measure affects (all

accidents, accidents involving young drivers, accidents in the dark, etc), preferably so that the number of "target" accidents can be estimated numerically

The effects of the measure on target accidents should known, i.e. numerical estimates of these effects should be available. If possible, these estimates should state the severity of accidents or injuries they apply to

It should be possible to describe the use of the measure in numerical terms.eg- number of junctions converted, number of cars equipped, number of drivers trained, man hours of police enforcementetc. This information is needed in order to estimate marginal costs and benefits of the measure

Costs of the measure should be known, and it should be known who pays the cost. Private and public expenditures are not treated identically in cost-benefit analysis. An opportunity cost of taxation is added to public expenditures, but not to private expenditures

Monetary valuations should be available for all impacts of the measure


Accuracy problem in Cost-benefit Analysis Rely heavily on past like projects(often differing markedly in function or size

and certainly in the skill levels of the team members) Rely heavily on the project’s members to identify(remember from their

collective past experiences) the significant cost drivers Rely on very crude heuristics to estimate the money cost of the intangible

elements Are unable to completely dispel the usually unconscious biases of the team

members(who often have a vested interest in a decision to go ahead) Determining which costs should be included in an analysis


Barriers to the use of Cost-benefit Analysis Fundamental barriers Rejecting the principles of welfare economics Rejecting efficiency as a relevant criterion of desirability Rejecting the monetary valuation of risk reductions Institutional barriers (barriers related to the organisation of policy making) Lack of consensus on relevant policy objectives Formulation of policy objectives inconsistent with cost-benefit analysis Priority given to policy objectives unsuitable for cost-benefit analysis Horse trading/vote trading Political opportunism Unfunded mandates and excessive delegation of authority Abundance of resources Rigidity of reallocation mechanisms Wrong timing of EAT information in decision-making process


Technical/methodological barriers Lack of knowledge of relevant impacts Inadequate monetary valuation of relevant impacts Inadequate treatment of uncertainty Barriers related to the implementation of cost-effective policy options Social dilemmas Vested interests in road safety measures Lack of incentives to implement cost-effective solutions Lack of marketing of efficient policies Strengths and Limitations Strengths Enables us to express an opinion on the economic-social convenience of a

project To create rankings among projects Encourages the practice of identifying the economic benefits and costs, even of

they are not immediately monetisable


Limitations Does not take redistributive effects into consideration Does not consider the effect on the economic return of non-monetisable benefits

or costs Sometimes uses discretional criteria for the monetisation of the costs and

benefits for which no market exists

Cost Management Practices

A cost control system can bring immediate savings and ensure that you remain competitive in the longer term

Eliminating wasteful activities is beneficial but indiscriminate cost cutting can lead to falling quality and poor morale

An organisation gains competitive advantage by creating more value for its customers than its competitors as customers demand enhanced value at reduced cost. Cost Management is one of the ways by which customers value could be enhanced

Value Analysis It is an approach to improve the value of a product or process by understanding

its constituent components and their associated costs Find improvements to the components by either reducing cost or increasing the

value of the functions


Phases of Value Analysis Job Plan Identify and prioritize functions Identify the item to be analysed and the customers for whom it is produced. List the basic functions (the things for which the customer is paying) Identify the secondary functions by asking ‘How is this achieved?’ or ‘What other

functions support the basic functions?’. Determine the relative importance of each function, preferably by asking a

representative sample of customers Analyze contributing functions Identify functions given by a product which have an importance(weight) and a

cost Measure the cost of each component as accurately as possible, including all

material and production costs Recording Ideas- Documentation of all the ideas generated during the analysis

phase is done without any filtration Speculation The objective is to develop a large quantity of ideas for performing each function

selected for study at less total cost and improved performance


Free flow of thought and ideas without criticism is required Investigation It represents a confrontation of ideas, a collection of information about the

feasibility and cost of ideas, and measures the value of the best alternatives This process usually involves determining the cost and selecting those ideas that

can be practically implemented Recommendation- To obtain concurrence and a commitment from the

designer, project sponsor and other management to proceed with the implementation of the recommendations

Implementation It is necessary to prepare a report that summarises the work that has been done,

including conclusions and specific proposals Describe action plans for implementation Application of Value Analysis It can be applied to everything- materials, methods, processes, services etc Items whose total annual consumption is high should receive top priorities in the

application of Value Analysis


Scarce materials, imported materials and monopoly items should also receive the attention of value analyst

The item should be taken up again for value analysis after six months or a year Organisation for Value Analysis It should be directly under a high ranking officer who has access to all

departments and their records, performance, costs etc VA is a team effort and the action needs to be taken is decided by

representatives from Design, Production, Purchase and Accounts Department VA refers to the analysis of an existing product, service or administrative

process while Value engineering refers to the same analysis applied to the product ,services or administrative processes that are under design and have not been finalised

Value Engineering It is a systematic approach aimed at achieving the desired functions of a

product, a process, a system or a service at minimum overall cost, without affecting quality, reliability, performance and safety


Job Plan Information gathering - Function analysis is usually done in this initial stage.

It tries to determine what functions or performance characteristics are important. It asks questions like; What does the object do? What must it do? What should it do? What could it do? What must it not do?

Alternative generation (creation) - In this stage value engineers ask; What are the various alternative ways of meeting requirements? What else will perform the desired function?

Evaluation - In this stage all the alternatives are assessed by evaluating how well they meet the required functions and how great will the cost savings be

Presentation - In the final stage, the best alternative will be chosen and presented to the client for final decision

When Value Analysis- Pg 38 Wastage Control-Pg 39


Business Process Re-Engineering It is basically the fundamental rethinking and radical re-design, made to an

organizations existing resources It is an approach for redesigning the way work is done to better support the

organization's mission and reduce costs Process Steps Set up a steering committee and a project team Analyze and document current processes including information flows Consult stakeholders/beneficiaries to detect problems/opportunities Identify change opportunities and present them to the steering committee - get

agreement on where and how to proceed Define new business processes, analyze and document the required

organizational changes and impacts Obtain approval from the steering regarding proposed changes Implement Monitor outcomes and anticipated benefits Adjust and fine tune as required


Critical Success Factors when implementing BPR components include: Well informed investment decisions Effective engagement with stakeholders Knowledge of the supplier marketplace Knowledge of the delivery chain Effective risk management Knowledge about operations Active management of intended outcomes and benefits Leadership BPR - Methodology Envision new processes Ensure management support Identify reengineering opportunities Identify enabling technologies Align with organizational strategy


Initiate change Set up the reengineering team Outline performance goals Process diagnosis An assessment must be done about how IT is aligned to creating value for the

business. Process redesign Develop alternative process scenarios Develop new process design Design human resource architecture Select IT platform Develop overall blueprint and gather feedback Reconstruction A checklist before cut-over to new capabilities includes asking: Is the organisation ready? Is the staff ready? Are businesses and/or citizens ready?


Is contract management in place? Is service management in place? Is benefits management in place? Is performance management in place? Are changes ahead been thought through Process monitoring checklist of key issues includes asking: Was the business case justification realistic? Have changes throughout the project compromise our original intentions Have we done a post-implementation review? Do we have enough qualified personnel to manage operations including

fulfilment contract with third parties? Are we actively seeking to improve performance? Are we measuring performance? Are we setting maturity targets? Pg 41


Total Quality Management It is an approach that seeks to improve quality and performance which will meet or

exceed customer expectations which can be achieved by integrating all quality-related functions and processes throughout the company

Principles of TQM Executive Management – Top management should act as the main driver for TQM

and create an environment that ensures its success Training – Employees should receive regular training on the methods and concepts

of quality Customer Focus – Improvements in quality should improve customer satisfaction Decision Making – Quality decisions should be made based on measurements Appropriate methodology and Tools should be used Continuous Improvement – Companies should continuously work towards

improving manufacturing and quality procedures Company Culture – The culture of the company should aim at developing

employees ability to work together to improve quality Employee Involvement – Employees should be encouraged to be pro-active in

identifying and addressing quality related problems


The Cost Of TQM Prevention costs are associated with the design, implementation and

maintenance of the TQM system. They are planned and incurred before actual operation, and can include

Product Requirements – The setting specifications for incoming materials, processes, finished products/services.

Quality Planning – Creation of plans for quality, reliability, operational, production and inspections

Quality Assurance – The creation and maintenance of the quality system. Training – The development, preparation and maintenance of processes. Appraisal costs are associated with the vendors and customers evaluation of

purchased materials and services to ensure they are within specification. They can include

Verification – Inspection of incoming material against agreed upon specifications

Quality Audits – Check that the quality system is functioning correctly Vendor Evaluation – Assessment and approval of vendors


Failure costs can be split into those resulting from internal and external failure. Internal failure costs occur when results fail to reach quality standards and are detected before they are shipped to the customer. These can include:

Waste – Unnecessary work or holding stocks as a result of errors, poor organization or communication

Scrap – Defective product or material that cannot be repaired, used or sold Rework – Correction of defective material or errors Failure Analysis – This is required to establish the causes of internal product

failure External failure costs occur when the products or services fail to reach quality

standards, but are not detected until after the customer receives the item. These can include:

Repairs – Servicing of returned products or at the customer site Warranty Claims – Items are replaced or services re-performed under warranty Complaints – All work and costs associated with dealing with customer’s

complaints Returns – Transportation, investigation and handling of returned items


Total Productive Maintenance The goal of the TPM program is to markedly increase production while, at the

same time, increase employee morale and job satisfaction TPM brings maintenance into focus in order to minimise downtime and

maximise equipment usage The goal of TPM is to avoid emergency repairs and keep unscheduled

maintenance to a minimum which helps to increase output and make it more uniform and predictable

Why TPM ? Avoid wastage in a quickly changing economic environment Producing goods without reducing product quality Reduce cost Produce a low batch quantity at the earliest possible time Goods send to the customers must be non defective


Similarities and differences between TQM and TPM : Total commitment to the program by upper level management is required in

both programs Employees must be empowered to initiate corrective action A long range outlook must be accepted as TPM may take a year or more to

implement and is an on-going process. Changes in employee mind-set toward their job responsibilities must take place as well.

The differences between TQM and TPM Pg 62 Types of maintenance : Breakdown maintenance- When the equipment failure does not significantly

affect the operation or production or generate any significant loss other than repair cost people wait until equipment fails and repair it

Preventive maintenance- It is a daily maintenance ( cleaning, inspection, oiling and re-tightening ), design to retain the healthy condition of equipment and prevent failure, the equipment service life can be prolonged by doing preventive maintenance


Periodic maintenance ( Time based maintenance - TBM)- Time based maintenance consists of periodically inspecting, servicing and cleaning equipment and replacing parts to prevent sudden failure and process problems

Predictive maintenance- This is a method in which the service life of important part is predicted based on inspection or diagnosis, in order to use the parts to the limit of their service life

Corrective maintenance- It improves equipment and its components so that preventive maintenance can be carried out reliably. Equipment with design weakness must be redesigned to improve reliability or improving maintainability

Maintenance prevention- It indicates the design of a new equipment. Weakness of current machines are sufficiently studied and are incorporated before commissioning a new equipment


Steps in introduction of TPM in a organization : Preparatory Stage Announcement by Management to all about TPM introduction in the

organization Initial education and training is to be done based on the need Committees are set up for improvement, autonomous maintenance, quality

maintenance etc Fixing up a target for achievement Introduction Stage This is a ceremony and we should invite all. Suppliers as they should know that

we want quality supply from them. Related companies and affiliated companies who can be our customers, sisters concerns etc. Some may learn from us and some can help us and customers will get the communication from us that we care for quality output

Implementation. Stage Institutionalising Stage- It is the time for applying for PM award and to think

of the challenging level to which you can take this movement

Product Life Cycle Costing

Pg 80 The LCC model (LCCM) is basically a simplified economic representation of the real world.

It provides the analytical structure from which the cost estimate is made. An LCCM typically develops cost projections

Types of LCC Models Parametric models- A parametric model estimates cost using a set of complex

mathematical or statistical equations that relate cost to system parameters such as design, performance, or operating characteristics, or the environment. Thesemodels are typically used during the very early stages of a program when cost-related historical data are limited or non-existent

Accounting models- An accounting model uses a set of relatively simpleequations to calculate and aggregate cost elements using direct data inputs andcost factors. Accounting models attempt to represent what actually happens in the real world using a structured set of basic accounting relationships to quantify all the relevant variable factors associated with each cost element

Simulation models- These models typically use probabilistic computersimulations to assess the LCC impacts of a system's operational and performance characteristics, basing and deployment concepts, operations and maintenance plans, and provisioning and support requirements. Although very accurate, the large amount of data required to generate the simulation normally limits the use of such models to the later stages of a program, when sufficient amount of detailed data are available

Activity-based Management

Activity-based Management(ABM) It is a method of identifying and evaluating activities that a business performs

using activity-based costing to carry out a value chain analysis or a re-engineering initiative to improve strategic and operational decisions in an organisation

Activity-based costing establishes relationships between overhead costs and activities so that overhead costs can be more precisely allocated to products, services or customer segments. Organisation achieves the same outcomes at a lower total cost

The focus of ABC is on accurate information about the true cost of products, services, processes, activities, distribution channels, customer segments, contracts and projects

Activity-based management focuses on managing activities to reduce costs and improve customer value


ABM can be divided into Operational ABM- It is about ”doing things right” using ABC information to

improve efficiency, lower costs and enhances asset utilisation It can increase the capacity of resources(equipment and people) by reducing

machine downtime, improving or eliminating faulty activities and processes, and increasing the efficiency of the organisation’s resources

Activities that add value to the product can be identified and improved Activities that don’t add value need to be reduced to cut costs without reducing

product value Strategic ABM- It is about “doing the right things” using ABC information to

decide which products to develop and which activities to use It can be used for customer profitability analysis, identifying which customers

are the most profitable and focusing on them more It encompasses decisions about product design and development where

opportunity for cost reduction exists


Process Management through Activity Networks Activity networks are used to determine the commitment of resources on

nonproductive processes of the organisation Understanding the costs of the exceptions will help you focus on ways to

eliminate these costs Difference between ABM and ABC Management gains a thorough understanding of its business processes and cost

behavior during the ABC analysis process Management applies the insights gained during ABC fact gathering and analysis

to improve decision making at both operating and strategic levels. This is the essence of ABM

ABC becomes ABM when it is used to Design products and services that meet or exceed customers’ expectations and can

be produced and delivered at a profit Signal where either continuous or discontinuous improvements in quality,

efficiency and speed are needed Guide product mix and investmenet decisions Choose among alternat1ive suppliers


Negotiate about price, product features, quality , delivery and service with customers

Employ efficient and effective distribution and service processes to target market and customer segments

Improve the value of an organisation’s products and services Outputs of ABM The cost of activities and business processes The cost of non-value-added activities Activity-based performance measures Accurate product/service cost Cost drivers- Factor that causes a change in the cost of an activity

Value Chain Analysis

Value Chain Analysis It helps an institution to determine which type of competitive advantage to

pursue and how to pursue it Two components of value chain analysis are- Industry value chain- value creating activities within the industry Organisation’s internal value chain Porter’s Five Forces- A model for Industry Analysis Threat of New Entrants New entrants to an industry can raise the level of competition, thereby reducing

its attractiveness The threat of new entrants largely depends on the barriers to entry High entry barriers exist in some industries (e.g. shipbuilding) whereas other

industries are very easy to enter (e.g. estate agency, restaurants)


Key barriers to entry include- Economies of scale- Capital / investment requirements- Customer switching costs- Access to industry distribution channels

Threat of Substitutes The presence of substitute products can lower industry attractiveness and

profitability because they limit price levels The threat of substitute products depends on:

- Buyers' willingness to substitute- The relative price and performance of substitutes- The costs of switching to substitutes

Bargaining Power of Suppliers Suppliers are the businesses that supply materials & other products into the

industry The cost of items bought from suppliers (e.g. raw materials, components) can have

a significant impact on a company's profitability. If suppliers have high bargaining power over a company, then in theory the company's industry is less attractive


The bargaining power of suppliers will be high when:- There are many buyers and few dominant suppliers- Suppliers threaten to integrate forward into the industry (e.g. brand manufacturers threatening to set up their own retail outlets)- The industry is not a key customer group to the suppliers

Bargaining Power of Buyers Buyers are the people / organisations who create demand in an industry The bargaining power of buyers is greater when

- There are few dominant buyers and many sellers in the industry- Products are standardised- Buyers threaten to integrate backward into the industry- Suppliers do not threaten to integrate forward into the buyer's industry - The industry is not a key supplying group for buyers


Intensity of Rivalry- The intensity of rivalry between competitors in an industry will depend on:

- The structure of competition - for example, rivalry is more intense where there are many small or equally sized competitors; rivalry is less when an industry has a clear market leader

- The structure of industry costs - for example, industries with high fixed costs encourage competitors to fill unused capacity by price cutting

- Degree of differentiation - industries where products are commodities (e.g. steel, coal) have greater rivalry; industries where competitors can differentiate their products have less rivalry

- Switching costs - rivalry is reduced where buyers have high switching costs - i.e. there is a significant cost associated with the decision to buy a product from an alternative supplier

- Strategic objectives - when competitors are pursuing aggressive growth strategies, rivalry is more intense. Where competitors are "milking" profits in a mature industry, the degree of rivalry is less

- Exit barriers - when barriers to leaving an industry are high (e.g. the cost of closing down factories) - then competitors tend to exhibit greater rivalry.


Limitations of Value Chain Analysis

One of the limitations of the value chain model is that it describes an industrial organization which essentially buys raw materials and transforms these into physical products

The limitations of the model include the fact that ‘value’ for the final customer is the value only in its theoretical context and not practical terms. The real value of the product is assessed when the product reaches the final customer, and any assessment of that value before that moment is only something that is true in theory

Steps in Value Chain Analysis Value chain analysis can be broken down into a three sequential steps: Break down a market/organisation into its key activities under each of the major

headings in the model Assess the potential for adding value via cost advantage or differentiation, or

identify current activities where a business appears to be at a competitive disadvantage

Determine strategies built around focusing on activities where competitive advantage can be sustained

Balanced Scorecard

Four barriers to strategic implementation Vision Barrier- No one in the organisation understands the strategies of the

organisation People Barrier- Most people have objectives that are not linked to the strategy

of the organisation Resource Barrier- Time, energy and money are not allocated to things that are

critical to the organisation Management Barrier- Management spends too little time on strategy and too

much time on short-term tactical decision-making With Balanced Scorecards, strategy reaches everyone in a language that makes

sense. When strategy is expressed in terms of measurements and targets, the employee can relate to what must happen which leads to much better execution of strategy

Balanced Scorecard

Balanced Scorecards It tells you the knowledge, skills and systems that your employees will need to

innovate and build the right strategic capabilities and efficiencies that deliver specific value to the market which will eventually lead to higher shareholder value

It has three elements Measurement System- It allows an organisation to translate its vision and

strategies by providing a new framework, which tells the story of the organisation’s startegy through the objectives and measures chosen. While the scorecard retains financial measures it complements them with three other distinct perspectives

Customer- Encourages the identification of measures that answer the question “How do customers see us?"

Internal Business Processes- Encourages the identification of measures that answer the question "What must we excel at?"

Learning and Growth- Encourages the identification of measures that answer the question "Can we continue to improve and create value?".

Balanced Scorecard

Strategic Management System By combining financial measures and non-financial measures in a single report,

the Balanced Scorecard aims to provide managers with richer and more relevant information about activities they are managing than is provided by financial measures alone

Communication Tool With the balanced scorecard, communication is easy. You are able to give your

employees the chance to participate in understanding the goals and the main mission of your company. This is essential since they have a big influence on the productivity of your business. Aside from that, you will give them an idea on how they can evaluate their performance and how they can contribute more so that your company will be able to accomplish the tasks and become successful

Process of Balanced Scorecard- Pg 113

Target Costing

Target Costing 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

It is the maximum amount of cost that can be incurred on a product and with it the firm can still earn the required profit margin at a particular selling price

It is a systematic process of cost management and profit planning It is used to plan or project the costs of products before they are introduced, and to

ensure that low-margin products are not introduced which do not bring sufficient returns

Four basic steps of target costing are- Define the product Set the price and cost targets Achieve the targets Maintain Competitive costs

Target Costing

Target Costing is based on three premises Orienting products to customer affordability or market-driven pricing Treating product cost as an independent variable during the definition of a

product’s requirements Proactively working to achieve target cost during product and process

development The following ten steps are required to install a comprehensive target costing

approach within an organisation Re-orient thinking toward market-driven pricing and priortise customer needs

rather than just technical requirements as a basis for product development A target price needs to be established based upon market factors such as the

company position in the market place, business and market penetration strategy, competition and competitive price response, targeted market niche or price point and elasticity of demand

Once the target price is established, a worksheet is used to calculate the target cost by subtracting the standard profit margin, warranty reserves and any uncontrollable corporate allocations

Target Costing

Before the target cost is finalised, it must be considered in conjunction with product requirements

Establish a target costing process and a team based organisation Brainstorm and analyse design alternatives for both the product and its

manufacturing and support processes at each stage of the development cycle Establish product cost models to support decision-making Use of tools and methodologies related to design to reduce costs A significant portion of a product’s costs(30-50%) are indirect, these costs must also

be addressed Measure reults and maintain management focus Target Costing Principles Price-led costing- Market prices are used to determine target costs

Target cost=Market price-required profit margin Focus on customers- Customer requirements for quality, cost and time are

incorporated in product and process decisions and guide cost analysis Focus on design- Cost control is emphasized at the product and process design stage

Target Costing

Cross-functional involvement- Cross-functional product and process teams are responsible for the entire product from initial concept through final production

Value-chain involvement- All members of the value chain,eg-suppliers, distributors, service providers and customers are included in the target costing process

A life-cycle orientation-Total life cycle costs are minimised for both the producer and the customer

Target Costing Process Estimate a selling price for the new product and estimated sales volume from an

analysis of the market and a target profit Determine the target cost by subtracting the profit from the selling price Perform functional cost analysis for individual components and processes Determine the estimated cost for the product Compare estimate with target If estimated cost exceeds target cost, repeat cost analysis/value engineering to reduce

estimated cost Make the final decision whether or not to introduce the product once the cost

estimate is on target Manage costs during production of the product

Target Costing

Advantages of Target Costing To reduce costs before they are locked in- Around 70 to 80% of product costs

are fixed during the design stage. Target costing provides a means to manage costs from the design stage to maximise the potential for cost reduction

To control design specifications and production techniques The discipline of target costing and the detailed review of costs can reveal more

general managerial problems As a driver for cost improvement Encourages focus on the customers- Target costing is market driven and

stimulates behavior which is customer focused and encourages all functions within the company to respond to market demand and competitive trends rather than internal performance indicators

Target Costing

Key characteristics of successful target costing Customer requirements for quality, cost and time are incorporated into the

product decisions and guide the analysis of costs Emphasis on cost reduction at early stages in product development Consideration of the whole product life cycle Target costing is the multidisciplinary nature of the process and the importance

of the involvement of all functions in the analysis and decision-making. Responsibility for achieving targets must also be shared across functions

Team members understand their role and how it impacts cost Involvement of the whole value/supply chain It is an iterative process where targets evolve as teams seek to balance

functionality, price, volumes, capital investment and costs

Cost Audit and Management

Audit It means the examination of the books of accounts and documents with a view

to verify the accuracy and correctness of the data shown in the financial statements

Audit may be broadly classified into two categories Statutory audit- It is an audit which is compulsory by any statue or law. Eg-

Audit of banking companies, insurance companies etc. Audit compulsory in certain specified companies to be notified by the central government from time to time

Non-statutory audit- Voluntary audits undertaken at the discretion of the management of the business. Eg-cost audit, internal audit, social audit etc

Cost Audit It is an audit of efficiency, of minute details of expenditure, while the work is in

progress and not a postmortem examination It is mainly a preventive measure, a guide for management policy and decision

in addition to being a barometer of performance


Types of Cost Audit Cost audit to assist management Accurate, relevant and prompt information is made available to management to

assist in making important decisions A cost auditor suggests ways to reduce the cost of production and to make an

improvement in the cost accounting plan Cost audit on behalf of the government The government may appoint a cost auditor to conduct cost audit where it is

necessary To ascertain correct cost of certain units when government is approached for

protection or financial help To ascertain correct cost of contract given to private firms under ‘cost plus’

basis To fix reasonable prices to certain items of production so as to prevent undue

profiteering


Cost audit on behalf of the customer Customer gets cost accounts of the product concerned audited to establish correct

cost so that he may be able to pay price on the basis of correct cost plus an agreed margin of profit

Cost audit on behalf of trade association To ascertain comparative profitability of its member To determine minimum price to avoid cut throat competition among its members To maintain prices at a certain level so as to prevent undue profiteering Cost audit on behalf of tribunals Labor tribunals may direct the audit of cost accounts to settle trade disputes for

more wages, bonuses To assess the correct profit for assessment purposes Cost audit under statue Certain classes of companies are required to maintain proper record regarding

materials consume, labour etc they are required to get their cost accounts audited The aim of such type of audit is that the government wants to be ascertaining the

relationship of costs and prices


Objectives of Cost Audit Protection of the business Detecting errors or ensuring that cost record are compiled correctly Checking accuracy of records in order to verify that cost accounts are correctly

maintained in conformity with accepted cost accounting principles adopted in the industry

Ascertaining whether procedures and routines as laid down by the management are properly and uniformly followed

Constructive appraisal The auditor acts as an advisory capacity for the well being of shareholder of the

company Judging whether existing procedure, submission of reports and returns are

adequate or wasteful. Changes may be introduced in conformity with modern costing techniques and unnecessary routines may be eliminated

Whether existing procedure is effective to the management for taking decisions Whether or not the projected expenditure to give the optimum results Whether the return from capital employed is adequate, if not, whether it can be

bettered


Pre-audit or prior concurrence Auditor sees whether the expenditure has already been provided for in the

budget estimates and that the cumulative expenditure up-to-date has not exceeded that provision

Comaprison of costs Comparison of the actual cost for the year is made with the cost pertaining to

previous years to ascertain whether cost has increased or decreased By making comparison of costs, the cost auditor is able to know abnormal costs.

These abnormal costs are brought to the notice of the management for taking remedial measures

Advanatges Pg 150

Strategic cost management

Documents

proper cost benefit

technical analysis

financial benefit

sensitivity analysis

net benefit

capital economic analysis

important cost

project scope