The way businesses approach cost control is changing drastically as the majority of industries continue to undergo digital transformations.
Gone are the days when companies hyper-focus on cost. The new version of cost control is a blended approach that focuses on cost management and driving growth.
While most businesses dread the idea of going over budget—simply cutting costs isn’t enough today. Instead, businesses must focus on context if they want to increase profits, optimize budgets, and ensure long-term financial sustainability.
Staying on course with proper cost control measures is a must, so let’s talk about cost control and its many facets.
What is cost control?
Cost control has to do with pinpointing business expenses and finding ways to reduce them to increase profits. It often works at the project-level, where decisions regarding the budget are based on the expected costs.
Managers compare the actual financial data with the initial budget expectations and take action if the actual costs end up higher than anticipated. For example, the company may choose to switch to a cheaper vendor or service, or outsource certain tasks in the event of a cost overflow.
This is why cost control and vendor management often go hand-in-hand, since optimizing how you interact with vendors can produce significant cost savings for your business. You may look to streamline contract renegotiations to lock in favorable prices, work to build sustainable relationships with vendors and customers, and create partnerships that complement both businesses.
After all—the goal of cost control is to give your company a powerful framework that’s designed to improve visibility and keep you in control of your costs.
Why cost control matters
Project schedules can be divided up into components and steps, and most managers allocate the overall budget to each part according to its needs. Making an effort to control costs helps:
- Track progress and KPIs (key performance indicators) and take corrective action when costs rise too high.
- Maintain expected profit margins.
- Set clear expectations and prevent scope creep.
- Achieve transparency with management, stakeholders, and clients.
- Generate useful metrics for handling future projects.
Having a proper budget in place directly impacts critical decisions like what new employees to hire, what features to include, and how much time should be spent on each part of the job. A well-kept budget that follows and organization’s business rules essentially shows you where the project is going and how it will end up. Project performance in this case is directly tied to its budgeting.
The role of cost control software
It’s no secret that cost management and control are data and analysis-heavy fields, and it’s no surprise then why software developers have found an application for automation here. Software-based management optimizes the process in multiple ways:
- Tedious calculations and other quantitative tasks are almost instant and immune to human error through software.
- Analysis is much easier when the data is clearly reported through dashboards and easy-to-use user interfaces.
- Standardization of data is automatic this way, which can be useful for projects on an international scale that must use multiple currencies.
- Third-party integrations with other management solutions help pool data more effectively.
Cost management vs. cost control
You may hear terms like “cost management” and “cost control” used interchangeably. While they are heavily related and equally important, there’s a subtle distinction that might be worth knowing whenever you’re talking with your teams about them.
Cost management primarily deals with all the processes regarding budget planning, including estimation, financing, and funding. To manage costs requires attention from the planning phases to final completion, ensuring the project as a whole stays within approved budgetary limits. A critical step of cost management is making both indirect and direct costs more predictable through strong accountability, control, and information gathering.
By comparison, cost control mainly deals with projects during their execution phase and relies on cost management practices for success. Having planners work with each other to achieve proper budgeting is how cost controls work.
When talking about cost controls, business owners first put down a “baseline” and then measure the variance between it and the actual cost, taking corrective action to minimize unexpected spikes.
Cost management: required steps
Handling business expenses is definitely not a “set it and forget it” consideration. Rather, think of it as a continuous, cyclical process that involves steps like the following.
Cost control starts by implementing project controls; predicting the upcoming costs of a project, whether it’s for equipment, materials, staff, or even just time spent. The resource planning step occurs before the actual work begins.
Companies often use the work-breakdown structure to examine each subtask in the schedule and decide on what skills or equipment are necessary for each. Historical financial data for comparable projects and feedback from team members are important points to consider for this task.
Next approximate the overall cost of resources needed for the work. Cost estimation is a complicated matter that depends on your current budget and how much information you have available. We’ll talk more about cost estimation later.
Once the work is underway, the next step is allocating the budget to each task. Cost budgeting is a combination of applying the estimated costs to project scheduling. Every activity in the workflow gets its own specific amount of the budget here.
Finally, project management needs to cover handling changes in the budget. Cost control measures the variance of the actual costs from the predetermined baseline cost and takes action whenever necessary. This step also requires you to check the actual results of those actions.
Cost estimation techniques to consider
We’ve mentioned estimation as an important step in managing costs. Let’s dig deeper by talking about some exact techniques for making accurate estimates, especially since budgeting for complex workflows can be a challenge.
Projects are almost never fully “figured out” when they begin. The scope might not be fully defined, and certain features may still need some work. It would be a waste of time to form a detailed budgetary analysis now since it would likely change quickly.
The factor estimation method is the fastest way to get a general overview of what to expect. The industrial sector is familiar with one convenient trick known as the sixth-tenths rule, where the expected cost goes up by six-tenths as the size of the manufacturing facility increases.
Past financial data is an invaluable tool for accurately predicting new expenses. Parametric methods involve analyzing previous contract prices and values and finding out the relationships between materials and labor in previous works.
For instance, you might notice that the thickness of the sheets of metal used in an engineering project consistently correlate to higher costs. Think about ways you can use that information the next time a similar project begins.
As the workload progresses, you will slowly gain more insight and have a clearer picture in your mind of how it will finish. The quantitative factor estimation builds on the “factor estimation” step from earlier by attaching empirical data you gain during project execution to figure out more precise estimations.
The resource-based technique is an option if time is considered a sensitive asset. Here, the team will estimate and manage the amount of time it takes to complete a certain portion of the work and schedule it to a calendar. Keeping the duration of the workload under control can be just as important as keeping monetary costs low.
It may seem obvious, but simply extrapolating the entire cost by using a smaller unit of cost as a benchmark is an effective method. For instance, a short pipe might cost $15 and require an hour of installation time. If you’re using 20 of these pipes, you can expect the cost to be around $300 and 20 hours of work.
While not always accurate (installation time may be shorter the more units you install at a time, for example), unit-rate will always be a tool on the table of any cost engineer.
Cost control takes time
You can’t pick up everything you need to know about cost control in an hour. The process is actually multifaceted and requires you to work closely with your employees and project managers. But you can be sure this effort will ultimately lead to increased productivity.
Finding the Baseline
Start the process by first establishing a baseline to compare against actual costs. Use historical financial data to find a realistic target and find a theoretical “ideal” final cost of the project.
Target Net Income
Target net income is a metric calculated by taking the reported profits from sales and subtracting the fixed costs and the variable costs. Reaching this amount is important, especially for public companies with investors who expect earnings growth over time.
As an example, imagine a business wants $15,000 in net income from $80,000 sales each month. The management looks at the fixed and variable costs and attempts to reduce them until the target net income is reached.
Variable costs include things like inventory, which can be reduced by switching to cheaper suppliers. Fixed costs are usually more difficult to change, as they are often things like lease payments that are on contract. Fixed costs also include the salaries used to pay employees.
Variance is the difference between budgeted and actual financials. When the actual cost is much higher than the expected figure, this high, negative variance deserves investigation to identify the cause and figure out solutions.
Variance analysis allows you to prioritize essential areas by discovering which ones need corrective actions the most.
Earned Value Management
One of the most popular approaches to cost analysis, earned value management (EVM) should be explained through example. Say that you have a task that you expect to be halfway done by the end of the week. The budget for it is $5,000.
If, however, the task is only 25% complete after one week, what implication is there for the project? We can say that the planned value is the project budget multiplied by the expected completion, which in this case is $5,000 x 50% = $2,500.
The actual value, however, is only $5,000 x 25% = $1,250. We can now calculate the scheduled variance by subtracting the planned value from the actual value: $1,250 – $2,500 = -$1,250.
Because the variance is negative, we can tell that this project is falling behind financially, signaling management to take corrective action.
Working Without a Budget
Not all businesses operate on an exact budget. However, you can still do cost control by plotting individual costs on an income statement. If there’s a sudden spike in prices, investigate it for potential fixes.
Common challenges of cost control
Even experienced companies occasionally have missteps during cost control operations. It’s worth going over a few pitfalls and challenges to the process as well. They include:
- Mistaking cost analysis with accounting: Accounting deals mainly with just counting up the costs among other tasks, whereas cost control goes deep into a project and plans out the funding.
- Consistently analyzing budget and predictions: Calculating the budget and predicting cost control is often performed by separate employees, resulting in inconsistent analyses that could compromise the reliability of the results.
- Aligning data from multiple sources: Relevant financial data can come from a variety of subcontractors and content management systems. It takes a degree of organization and skill to ensure all this data is usable.
- Aligning time and money: In the same vein, there’s a discrepancy between project schedulers who schedule the workload according to activities and tasks and cost analysts who use transactions and fiscal periods. Making these two sources comparable is another challenge of cost control.
- Accommodating project changes: As a project goes along, the scope, features, or goals may change over time. How does cost control, which relies on predicting future expenses, work around this challenge?
- Controlling the cost of cost control itself: It can be time-consuming and error-prone to perform cost control, from the data collection to the analysis to executing the corrective actions. What results is another form of cost to consider.
Regardless of the setbacks, a well thought-out cost control system can set an organization up for success. Standardizing the process and giving the company flexibility is the best way to deal with complicated or changing projects.
Investing in technology is one of the best steps to take to boost the chances of project success and minimize risks.
Looking to implement a cost control system built around best practices?
You now know the basics of cost control, key benefits, and potential challenges you may encounter when implementing a cost control system.
It’s important to remember that to have a competitive advantage, cost control requires constant communication and collaboration among everyone in your team. A successful initiative means starting small, defining your expectations early, understanding your costs and risks, and leveraging the right cost management software.