Cost management involves the process of planning and controlling the budget of a business. It is a form of management accounting that allows a business to predict impending expenditures to help reduce the chance of going over budget.
Many businesses employ cost management plans for specific projects, as well as for the overall business model. When applying it to a project, expected costs are calculated during the planning phase and are approved beforehand. During the project, all expenses are recorded and monitored to ensure they stay in line with the cost management plan. After the project is finished, the predicted and actual costs are compared, which helps inform future cost predictions and plans.
Key components of cost management include:
- Cost Estimating: Predicting the cost of a particular task or project.
- Cost Budgeting: Aggregating the estimated costs to establish an authorized cost baseline.
- Cost Control: Ensuring the actual cost aligns with the projected cost.
Good cost management strategies can help a company increase profits by reducing costs without compromising the quality of products or services. It can also improve the accuracy of budget forecasts, prevent cost overruns, and provide a better understanding of costs and profits at the product, project, and company-wide levels.
Example of Cost Management
Let’s consider a hypothetical construction company called “BuildRight” that is preparing to undertake a new building project. Here’s how BuildRight might implement cost management for this project:
- Cost Estimating: First, BuildRight needs to estimate the costs of the project. This involves forecasting the costs of labor, materials, equipment, permits, and any other expenses that will be incurred during the project. Suppose BuildRight estimates the total cost of the project will be $500,000.
- Cost Budgeting: Next, BuildRight creates a budget based on these estimates. The budget will allocate specific amounts to different categories of costs, such as $200,000 for labor, $250,000 for materials, and $50,000 for other costs. This budget serves as the authorized cost baseline for the project.
- Cost Control: Once the project begins, BuildRight needs to closely monitor the actual costs and compare them with the budgeted amounts. For example, if the actual cost of labor is running higher than expected, BuildRight might need to find ways to reduce costs in other areas to stay within the overall budget. Regular cost control checks help ensure that the project doesn’t go over budget and can identify potential issues before they become major problems.
By the end of the project, BuildRight can compare the estimated costs with the actual costs. This information can then be used to improve the accuracy of cost estimates for future projects.
In this way, effective cost management helps BuildRight to complete the project within budget, increase profitability, and make better-informed decisions for future projects.