For any business, making good profits would be a primary concern. By definition, profit is made when revenues exceed costs. At any given period, profit is revenue net of the costs made in that period. This is why businesses aim both to increase revenues and keep costs at a reasonable level. However, keeping costs reasonable does not necessarily mean not spending any money at all. After all, any business needs to spend money on inputs, in order to be able to produce outputs, whether in the form of services or goods.
To this end, a business needs to have a regular budget for its regular activities. This includes overhead costs, such as rent, utilities, and the like. This also includes actual inputs, like raw materials, salaries, marketing costs, and other things that contribute to making a product and selling it in the market. This budget should not be too excessive, and therefore cost control methods are often used by businesses to manage their costs, such that these would not overshoot.
Planning. Cost control methods are primarily used for planning a business’ expenditures for the short, medium and long-term. Any business manager would have an idea of what kind of expenses are necessary to keep the business running. Therefore, a manager or entrepreneur can plan how much needs to be spent in the next business periods, in order to make products or render services to customers.
These are usually estimates, based on current market prices, and quantities required for the business to render the needed output. For instance, a manager can estimate how much salaries he will be paying his employees based on the current employee roster, and their salaries. Another example is that a company that creates food products can estimate how much will be spent buying ingredients. These all contribute to the budget that will be spent for the current period.
Comparison and the standard cost system. Part of cost control is comparing actual expenditures with what is called a standard cost system. Simply put, this means that a business should compare its past expenses with the cost of these expenses based on acceptable standards. This would include set price limits, such as minimum wages, suggested retail (or wholesale) prices, and the like.
For instance, a company that employs factory workers paid at minimum wage would usually compare the actual wages paid to the workers. Another example is the comparison between the prices of inputs like electricity and utilities, compared to the actual use, which can fluctuate depending on the season. Comparing the actual cost against the estimated or standard costs would then help a manager determine if the company is spending too much, compared to the planned budget. This way, the company can then determine where it can cut costs in order to stay within budget.
Cost control methods are important in ensuring a company is financially healthy. Planning, budgeting and regular evaluation would aid a manager in staying within budget, especially given changing prices of materials, labor, cost of capital, and the like.