“Cost control” is operated through setting standards of targets and comparing actual performance

therewith, with a view to identify the deviations from standard norms and taking corrective actions in
order to ensure that future performance conforms to standard norms. In other words it can be
explained that it is a scientific management technique to control and reduce the costs of doing business.
It is more of an activity than a theory. Every industry and company has its own standards to control
costs. Cost control is concerned with the ways and means of keeping the costs at a lower level, without
affecting efficiency and effectiveness. According to Eric L. Kohler, cost control is the employment of
management devices in the performance of any necessary operation so that pre-established objectives
of quality, quantity and time may be attained at the lowest possible outlay for goods and services. Such
devices include a carefully prepared and reviewed bill of materials; instructions; standards of
performance; competent supervision; cost limits on items and operations; and studies, interim reports
and decisions based on these reports. In short, it is the regulation by executive action of the costs of
operating and undertaking. The essential requirement of cost control is to fix reasonable targets for all
important activities, in consultation with employees who are responsible for achieving them. In the next
step, the actual performance should be compared with the targets at periodic intervals. Important
deviations must be identified, analysed and brought to the notice of those responsible for results. The
executives must also find out the reasons for deviations and initiate remedial measures immediately.
Important techniques like standard costing and budgetary control may be put to use in order to ensure
cost control. Cost control means regulation of the costs of operating a business by executive action, i.e.,
it is the function of keeping expenditure within acceptable limits. It should not be confused with cost
reduction. Cost control is achieved by fixing standards of performance, collecting actual cost data for
each area of responsibility, comparing actual data with standards and forwarding prompt report to top
management highlighting the deviations from standards from immediate corrective action. Thus, cost
control compels actual costs to conform to planned costs.

Kohler defined the word “Control” as “The process by which the activities of an organisation are
conformed to a desired plan of action and the plan is confirmed to the organisation’s activities.” Cost
control has been defined by Kohler as “The employment of management devices in the performance of
any necessary operation so that pre-established objectives of quality, quantity and time may be attained
at the lowest possible outlay for goods and services. Such devices include a carefully prepared and
reviewed bill of materials; instructions, standards of performance; competent supervision; cost limits on
items and operations; and studies, interim reports and decisions based on these reports”. The technique
of cost control involves the determination of standards in respect of each item of cost, ascertainment of
actual costs regarding those very items, detection of variations of actuals from the standards laid down,
analysis of these variances so as to determine the responsibility and the cause and cost of each variance,
and then taking necessary action to ensure that actual costs conform to standard costs in future. The job
of cost control is not as simple as a casual reader may suppose. There are a number of problems which
have to be successfully solved if cost control is to be applied in any industrial unit.

The Institute of Cost and Management Account, London define Cost Control as- “The regulation by
executive action of the cost of operating an undertaking particularly where such action is guided by cost
accounting”. The terms ‘regulation’ and ‘executive’ ‘action’ indicate conscious attempt of regulating the
cost on the basis of predetermined ideas about what cost should be.

Features of Cost Control

The following features of cost control are:

1. Existence of Cost Accounting: If cost accounting should guide executive action to regulate costs, it is,
first of all, necessary to install a suitable system of cost accounting. The system introduced, should be
designed to suit the undertaking. It should not be introduced merely because other concerns have done
it, and it is fashionable to do so. The cost accounting system so installed, accomplishes one of the twin
objectives of cost accounting, viz., cost ascertainment.

2. Predetermined Standards: Another requirement of cost control is the fixation of attainable targets of
performance. The targets set, should be scientific, taking into consideration all practical aspects
governing production as well as the related costs. For fixation of targets of performance, it is not
necessary to introduce standard costing. The same may be accomplished by the budgeting process also.
The persons responsible for achieving the targets should be convinced that they are capable of achieving
the same under normal conditions.

3. Cost Reporting: As pointed out above cost control does not come about automatically. Executive
action for cost control should be guided by cost accounting. If cost accounting should guide the
executives, there should be an effective system of reporting cost information. The reports should point
significant deviations from the predetermined targets, and not merely historical costs. Cost reporting is
to be accomplished at the appropriate time and not when it is too late to do anything.

4. Corrective Action: Even effective and timely reporting of cost information would be of little use if
corrective action is not taken then and there. Action should also be taken to see that significant
deviations which are now corrected by executive action are not allowed to appear all over again. In
other words, corrective action should be to prevent the recurrence of deviations.

5 Elements Involved in Cost Control System

Efficient organisation and operation of cost control system involves the following elements:

1. Setting up the targets.

2. Measurement of the actuals.

3. Comparison of actuals with the targets to ascertain variances.

4. Analysis of variances (between the targets and the actuals) to their causes.

5. Taking such corrective actions as are necessary to eliminate the variations.

Process of Cost Control

1. Planning: Initially a plan or set of targets is established in the form of budgets and standards.

2. Communication: The next step is to communicate the plan to those whose responsibility is to
implement the plan.

3. Motivation: Motivation is defined as the process that initiates, guides, and maintains goal oriented
behaviors.

4. Appraisal and Reporting: comparison has to be made with the predetermined targets and actual
performance. Deficiencies are noted and discussion is started to overcome deficiencies.

5. Decision-making: Finally, corrective actions and remedial measures are taken or the set of targets are
revised, depending upon the administration’s understanding of the problem.

Cost Control – Top 18 Techniques

Cost control is exercised through numerous techniques some of which are given below:

1. Standard Costing,

2. Budgetary Control,

3. Inventory Control,

4. Control of Capital Expenditure,

5. Quality Control,

6. Performance Evaluation,

7. Accounting Ratios etc.

8. Work Study

9. Market Research

10. Value Analysis

11. Production Planning and Control

12. Standardisation and Simplification

13. Automation

14. Job Evaluation and Merit Rating

15. Study of Organisation and Methods.

16. Improvement of Design.

17. Operational Research

18. Statistical Techniques

6 Key Points for Exercising Effective Cost Control

The cost control process involves setting of cost centers (responsibility centers), both personal or
impersonal, followed by pre-determination of costs function-wise or product- wise. This is followed by
monitoring and control and by comparing actuals with standards. Standard costing is one of the
techniques widely used for cost control purpose. In addition, budgetary control provides the basis for
controlling expenditure and means to appraise, the potential profitability of an alternative course of
action.

The following key points are worth mentioning for exercising effective cost control:

(i) Quantity and price standards should be set to, or be estimated for, each physical unit. The factors
influencing variances should not be ignored (inadequate facilities, poor organisation and poor
materials).

(ii) To make the standards realistic, all concerned should be associated in determining standard costs.

(iii) The data collected should be kept to a minimum, and proper collection and processing of cost
control data are important.

(iv) The different variances, price, usage, mix and efficiency should be considered, whether they are
relating to materials, labour or overheads.

(v) No amount of detailed analysis of the cost of variances can undo what has already been done;
however, control measures should ensure that such mistakes are not repeated. The only way to prevent
excess costs in practice is for the manager to take action before the event.

(vi) The essentials of effective cost control not only include realistic targets (based on work study data)
but also flexible attitudes regarding the standards set. Cost control does not necessarily mean reducing
the cost but its aim is to have the maximum utility of the cost incurred. In other words, the objective of
cost control is the performance of the same job at a lower cost or a better performance for the same
cost.

8 Basic Measures to be Adopted for Effective Cost Control System In order to carry out cost control
system efficiently so as to obtain the required results, there are certain basic measures which should be
adopted.

These measures may be given as follows:

1. The targets for performance of work as well as the costs to be incurred for the purpose should be laid
down for each area of responsibility as far as practicable. It would enable to locate the exact person
responsible for a given state of affairs. The powers, responsibilities and obligations of each executive in
the organisation should be clearly defined.

2. The target should always be fixed up in consultation with the individual responsible for attaining the
target. The impression should never be created that the target is purely a result of some calculations in
the accounting department. Further, the targets should be ‘attainable’ and not merely ‘ideal’. If the
targets are not attainable even in the best of circumstances, a certain amount of frustration will be
created in the minds of the persons concerned and the whole object of the cost control will thereby get
defeated.

3. The targets fixed in an undertaking should not be treated as permanent. They should be reviewed
whenever necessary and should be revised when conditions change.

4. Collection of costs should be made by each area of responsibility and reports thereon should be
drawn up similarly. These reports should clearly indicate in monetary terms the effect of efficiency or
inefficiency shown by each section or department.

5. The reports should be presented sufficiently in time for necessary action to be taken. Belated
presentation of reports will only give statistical information and cannot be helpful in taking an action.

6. Utmost care should be exercised while making a judgement about the efficiency or inefficiency of
various persons on the basis of the reports. A single report is likely to be misleading under certain
circumstances and hence a number of reports should be considered together.

7. A proper and thorough enquiry into factors leading to exceptionally good or bad performance should
be made and appropriate remedial action should be taken. The main objective should be to locate and
remove the factors leading to wastage and losses rather than to punish people. If there is too much
emphasis on punishment, it is possible that figures will be cooked and the truth hidden.

8. A good performance should attract immediate reward and consistently bad performance should
attract the necessary dis-incentive. It should also cover those whose task is to prepare reports.

Tools of Cost Control

1. Cost Estimate: This tool is used in the initia phase. In this phase, the users are responsi

for evaluating the financial viability of a particular project.

2. Budget: This tool is used in the planning phase. In this phase, the users plan out the work by
considering the overall cost estimat and converting the same into a budget.
3. Cost Monitoring: This is used in the executi phase. In this phase, the users monitor their costs in order
to check if there is not any so of overspending or unnecessary spending s that they can keep the
expenditures in line the budgetsBudgetsBudgeting is a method used by businesses to make precise
projections of revenues and expenditure for future specific period of time while taking account various
internal and external factor prevailing at that time.read more.

4. Financial Evaluation: This is used in the closing phase. In this phase, users evaluate a particular project
has met the pre-determine financial targets or not.

Advantages of cost control

1. It enhances the creditworthiness of a company.

2. It helps in enhancing the return on capital employed Return On Capital EmployedRetur on Capital
Employed (ROCE) is a metric tha analyses how effectively a company uses it capital and, as a result,
indicates long-term profitability. ROCE=EBIT/Capital Employed.read more for an organization.

3. It helps the management in increasing productivity with the available resources.

4. This mechanism helps an organization in enhancing the volume of profits with minim sales and
output.

5. This system helps the employees in sourcin jobs continuously.

6. This system helps the employees in earning reasonable remuneration and incentives.

7. Prosperity and economic stability of the industry.

Disadvantages of cost control

These are disadvantages of cost control:

1. Reduces flexibility and process improvement in a company.

2. Restriction on innovation.

3. Requirement of skillful personnel to set standards.

CONCEPT OF PROFITABILITY

MEANING OF PROFITABILITY

FACTOR AFFECTING PROFITABILITY

The essence of profitability is a firms Revenue – Costs with revenue depending upon price and quantity
of the good sold.

1. The degree of competition a firm faces.

If a firm has monopoly power then it has little competition. Therefore demand will be more inelastic.
This enables the firm to increase profits by increasing the price. For example, very profitable firms, such
as Google and Microsoft have developed a degree of monopoly power, with limited competition.
However, in theory, government regulation may prevent monopolies abusing their power, e.g. the OFT
can stop firms colluding (to increase price) Regulators like OFGEM can limit the prices of gas and
electricity firms.

2. If the market is very competitive, then profit will be lower. This is because consumers would only buy
from the cheapest firms. Also important is the idea of contestability. Market contestability is how easy it
is for new firms to enter the market. If entry is easy then firms will always face the threat of
competition; even if it is just “hit and run competition” – this will reduce profits.

3. The strength of demand. For example, demand will be high if the product is fashionable, e.g. mobile
phone companies were profitable during the period of rising demand and growth in the market.
Products which have falling demand like Spam (tinned meat) will lead to low profit for the company.
Some companies, like Apple, have successfully carved out strong brand loyalty making customers
demand many of the new Apple products. However, in recent years, profits for mobile phone companies
have fallen because the high profit encouraged oversupply, negating the increase in demand.

4. The state of the economy. If there is economic growth then there will be increased demand for most
products especially luxury products with a high- income elasticity of demand. For example,
manufacturers of luxury sports cars will benefit from economic growth but will suffer in times of
recession.

5. Advertising . A successful advertising campaign can increase demand and make the product more
inelastic demand. However, the increased revenue will need to cover the costs of the advertising.
Sometimes the best methods are word of mouth. For example, it was not necessary for YouTube to do
much advertising.

6. Substitutes , if there are many substitutes or substitutes are expensive then demand for the product
will be higher. Similarly, complementary goods will be important for the profits of a company.

7. Relative costs . An increase in costs will decrease profits; this could include labour costs, raw material
costs and cost of rent. For example, a devaluation of the exchange rate would increase the cost of
imports, and therefore companies who imported raw materials would face an increase in costs.
Alternatively, if the firm is able to increase productivity by improving

technology then profits should increase. If a firm imports raw materials the exchange rate will be
important. A depreciation making imports more expensive. However, a depreciation of the exchange
rate is good for exporters who will become more competitive.
8. Economies of scale . A firm with high fixed costs will need to produce a lot to benefit from economies
of scale and produce on the minimum efficient scale, otherwise average costs will be too high. For
example in the steel industry, we have seen a lot of rationalisation where medium-sized firms have lost
their competitiveness and had to merge with others.

9. Dynamically efficient. If a firm is not dynamically efficient then over time costs will increase. For
example, state monopolies often had little incentive to cut costs, e.g. get rid of surplus labour. Therefore
before privatisation, they made little profit, however with the workings and incentives of the market
they became more efficient.

10. Price discrimination . If the firm can price discriminate it will be more efficient. This involves

charging different prices for the same good so that the firm can charge higher prices to those with
inelastic demand. This is important for airline firms.

11. Management. Successful management is important for the long-term growth and profitability of
firms. For example, poor management can lead to a decline in worker morale, which harms customer
service and worker turnover. Also, firms may suffer from taking wrong expansion plans. For example,
many banks took out risky subprime mortgages, but this led to large losses. Tesco suffered from
expanding into unrelated business, like garden centre. This led to over-stretching the company and
losing sight of their core business.

12. Objectives of firms . Not all firms are profit maximising. Some firms may seek to increase market
share, in which case profits will be sacrificed to gain market share. For example, this is the strategy of
Walmart and to an extent Amazon.

13. Exchange rate. If a firm relies on exports, a depreciation in the exchange rate will increase

profitability. A fall in the exchange rate makes exports cheaper to foreign buyers. Therefore, the firm can
sell more or choose to have a bigger profit margin. If the firm imports raw materials, a depreciation will
increase costs of production.

HOW TO IMPROVE PROFITABILITY: 8 STEPS FOR MANAGERS

1. Learn to Read Financial Statements

The first step is to familiarize yourself with three key financial statements: the balance sheet, income
statement, and cash flow statement. Here are several resources to get

started:

The Beginner’s Guide to Reading & Understanding Financial Statements

Balance Sheets 101: What Goes On a Balance Sheet?

How to Read & Understand a Balance Sheet

How to Read & Understand an Income Statement

How to Read & Understand a Cash Flow Statement

Determine which pieces of these statements you can control as a manager. A baseline understanding of
the balance sheet, income statement, and cash flow statement can give you a clearer picture of what
your business is spending and earning, and lead to productive conversations with other decision-makers
about budgeting and efficiencies.

2. Calculate the Profitability of Future Projects

One way to gauge the impact you can have on your company’s financial health is to calculate projects’
predicted profitability . There are three metrics to consider when doing so: net present value, internal
rate of return, and payback period. The net present value (NPV) is the amount of money a particular
investment is worth to your organization today. This calculation takes both the time value of money—
the concept that your money is worth more now than the same amount is in the future—and the
inherent risk of investment into consideration. If a project’s NPV is a positive number, the project is
expected to be profitable. The internal rate of return (IRR) is the discount rate that sets the NPV equal to
zero. In other words, when using the IRR, your project would neither be profitable nor losing money.
Your project’s discount rate must be lower than its IRR to be profitable. For instance, if you were to find
that the IRR for a project is three percent, but the project’s discount rate is five percent, you can predict
that the project will not be profitable and pivot accordingly. The payback period is how long an
investment will take to pay back the initial cost. It’s useful to know how quickly you expect to see a
return on your investment when pitching projects and planning budgets.

3. Find Efficiencies in Your Processes

Analyze your company’s income statement and notice the expenses. Are there any items that can be
eliminated by streamlining processes? Which line items do you have control over, and can any be
reduced or eliminated? Conducting an audit of your expenses and pruning away process inefficiencies
are necessary steps toward improving your company’s profitability.

4. Create Budgets and Stick to Them

Knowing how to create a budget is an essential skill for managers . Familiarize yourself with your firm’s
budgeting timeline, procedures, and financial statements so you can create a budget that equips your
team to complete projects that drive profitability and performance. Track each action item your team
completes so you can compare your actual spending against projected costs. This can allow you to learn
from mistakes and make better financial decisions moving forward.

5. Conduct Market Research

Conducting market research can help you learn about your current and potential customers’ mindsets.
Options for undergoing market research range from inexpensive (for example, a free online survey) to
expensive (for instance, bringing in an outside vendor to conduct in-person focus groups). No matter
which option you choose, having these insights can be invaluable.

Perhaps your potential customers would be willing to pay $100 more for your product if it had a certain
feature, or maybe your current customers would be more likely to buy from you again if they received a
discount the second time. These insights could improve your organization’s profitability, but you won’t
know until you ask.

6. Offer Bundled Products

If your company offers a variety of products, it could be in your best interest to offer two or more
together for a lower price than if they were each purchased separately. "Bundling is pervasive in several
markets, and it works in many cases," says Vineet Kumar, an assistant professor in the Marketing Unit at
Harvard Business School, in Working Knowledge . Kumar cautions, however, that if bundling is the only
option, it could impact sales negatively. “It’s crucial to allow that kind of flexibility to the consumer,”
Kumar says. Per his research , consider pitching the idea of offering a bundled option alongside your
individual product offerings— a tactic called mixed bundling. Kumar and his co-author, Timothy
Derdenger, found that a pure bundling solution, in which no individual products are available, caused a
20 percent reduction in sales, and that a mixed bundling solution yielded higher revenue increases than
both pure bundling and individual product sales.

7. Dedicate Time to Training New Hires

A recent survey found that 40 percent of employees who receive poor training leave their jobs within
the first year. Considering the cost of replacing an employee can range from one-half to two times the
employee’s salary, it’s in the best interest of your organization to train new hires thoroughly and
effectively. Doing so can not only lead to a greater sense of self-efficacy and aid in employee retention,
but also help mitigate costly mistakes down the line.

8. Foster Engagement in Your Employees

Research by Gallup shows the employee engagement rate in the US is at an all-time high: 38 percent.
The downside is that 13 percent of workers report feeling actively disengaged, leaving 49 percent
somewhere in between. To engage your employees , consider a few of the strategies

below.

.. Solicit feedback from your team and act on the results

. . Communicate transparently across teams and business levels

.. Provide constructive feedback based on observations

.. Recognize your employees for their work and opinions

.. Support your employees’ learning and development

.. Delegate tasks to your employees to demonstrate your trust in their abilities

If managers and human resource professionals work to better engage their “actively disengaged”
and “in-between” employees, an increase in productivity and decrease in turnover rate could follow,
which would positively impact profitability.

ADVANTAGES AND DISADVANTAGES OF PROFITABILITY INDEX

The profitability index is a tool which investors can use to understand the degree of expected profits
that may come from a specific investment. To calculate the profitability index, you will first need to
know how much you intend to invest to get the returns you want for the future. Then you include the
NPV (net present value), which is the current price of the future cash flow that is anticipated. After
you’ve calculated the NPV, you would divide the present value of the cash flows by the total initial
investment to arrive at the figure. The final result would then let you know if the investment will achieve
the gains you’re hoping to obtain or if a better investment opportunity might be needed in the future.

Here are some of the advantages and disadvantages of the profitability index to consider before using
this tool in your own personal investments.

List of the Advantages of a Profitability Index

1. It provides you with information about how an investment changes the value of a firm. When you’re
calculated the profitability index, you’re getting to take a peek at what a potential investment may offer
to the overall value of the business involved. It gives you an opportunity to see if your investment makes
a real difference in their bottom line, which creates profit opportunities for you, or if the results would
be negligible. With this information, you can determine if your value will improve the value of everyone
involved or be absorbed into what everyone else is doing.

2. It will take into consideration all cash flows from a project. Some investment tools will only use
published cash flows or exclude certain cash flows that don’t reach the books to create investment
results. The profitability index takes a different approach. You’re using all of the cash flows that are
generated from the business, even the one which are not classified on the books as outgoing or
incoming cash flows, to determine what your NPV will be. That means you have more valuable data to
consider when deciding if an investment makes sense.

3. It will take the time value of money into consideration in the calculation. Money will invariably have
value throughout history. The difference is the value of that money. In 1934, you could purchase a lot
more for $1 than what is available today. Even the value of money from 2010 is different than the value
of 2018 money because of inflation. In 2010, if you were to purchase something for $1, then that same
item would cost $1.16 today, according to a standard inflation calculator. Your profitability index will
take these changes into account to ensure your information is as accurate as possible.

4. It considers the risks which are involved with future cash flows. Cash flows are uncertain, even if there
are incoming or outgoing cash flows which happen regularly. If this risk is not accounted for, then it
becomes difficult to fully understand what may occur over the life of the investment. A better picture of
the risks will also give you an idea of the profits that can be earned over time while understanding what
the final costs may be at the end of the calculated period.

5. It will give you information about ranking projects while still rationing capital. Investments happen all
the time in the business world. The profitability index does more than calculate an equity investment for
individuals. Companies can also use this tool to determine if certain projects are worth an investment in
the future. These figures can let them know if one project will be more profitable than another, which
allows them to choose the better option for long- term development and growth.

6. It is an investment tool that is easy to understand. The formula used to create the profitability index is
one that uses simple division only. As long as you know the present value of all cash flows and the initial
investment, then you can determine the answer that this tool provides. Although more than just this
tool should be used to make investment decisions, the answer will give you a base value of 1. If your
calculation is less than 1, then the project has more risk associated with it. If the calculation is above 1,
then there are fewer risks associated with the project.

List of the Disadvantages of a Profitability Index

1. The information generated is based on estimates instead of facts. There is no getting around the fact
that facts are not used to calculate the profitability index. You’re using a best-guess estimate as to what
future cash flows will be, using current information. In the world of business, there are no guarantees.
What may be a lucrative opportunity today could be a terrible investment idea tomorrow. If there are
changes to the cash flows that are unanticipated, then the NPV will be incorrect and the profitability
index will be useless to use.

2. It may not provide correct decision-making criteria for certain projects. The NPV creates an
investment figure that is based on short-term projects more than long-term results. If a company were
to evaluate a project looking at the short-term profit potential, then it may undervalue what the long-
term profitability of a project may be. The profitability index tends to score short-term gains better than
long-term gains, which means some companies may choose the wrong project to complete what
comparing their options.

3. The tool ignores what is called the “sunk cost.” When a project is being started, capital budgeting
classifies the costs that are incurred before the starting date as a “sunk cost.” If you have research and
development costs for a project before you reach the groundbreaking stage, then the R&D would
qualify. The profitability index does not include these incurred costs as part of the cash outflows which
are calculated. Ignoring these costs could have big consequences for a corporation, including the denial
of a financing plan, because only the information from the profitability index was used.

4. It can be difficult to estimate opportunity costs. The cash inflows and outflows are not the only
estimates which are used when calculating a profitability index figure. You’re also forced to estimate the
opportunity cost, which is defined as a cost which occurs by not accepting alternatives which could have
generated a positive cash inflow. Some agencies may not even attempt to calculate these costs. If the
alternatives are difficult to estimate, the results from the profitability index may be distorted.
5. The profitability index often relies on optimism. A profitability index is usually calculated by people or
teams that are close to the projects or companies being examined. Investors often look at equity
opportunities that they feel close to at first, for example, or an executive team may calculate the
profitability index with optimistic figures because they have high hopes for a specific project. Before
making a final decision, a review of all cashflow projections must occur because internal projects are
often high, which creates an upward bias when trying to create your final estimates. The profitability
index is one of many tools that can be used to determine the full potential of an investment
opportunity. It must be used carefully, however, because much of the information that is used to
calculate results is based on estimates. Use this tool with other investment tools, while managing
internal bias when it occurs, to achieve the best possible results.