Strategic Cost Management and Budgeting

What does the term cost management mean? Who in the typical firm or organization is responsible for cost management?

Cost management is the operation of preparation, development, and regulating a budget. It encompasses additional tasks such as balancing costs, finding funding, and managing finances in order for any given project can be fulfilled using the available and allocated budget. Cost management is utilized by businesses to manage individual projects as well as their comprehensive budget. Cost management is conducted by a collaboration of various departments and figures within an organization.

However, the primary burden lies with the accounting department, which keeps track of all costs and expenses. A financial manager may be involved in providing projections and analytics. Finally, project managers are responsible for maintaining expenses within the allocated budget. An organization may choose to employ external specialists to develop a cost management plan and support accountability.

What is a SWOT analysis? For what is it used?

SWOT analysis is a preparation and evaluation method used by organizations or businesses in developing a strategic plan of action. SWOT is an acronym that stands for strengths, weaknesses, opportunities, and threats. It is commonly found to be portrayed in a 4-way matrix, which allows to list and compare these various aspects of company operations. Through the use of SWOT analysis, clear objectives and barriers can be identified for any given entity, venture, or structure, presenting internal and external qualities that may be influential. Executive decision-makers in any given organization use SWOT analysis for strategic management to make informed decisions and evaluating whether an objective is feasible.

How do total variable costs, total fixed costs, average variable costs, and average fixed costs react to changes in the cost driver?

Changes in the cost driver serve as a stimulus for reaction in several types of costs. Total variable costs will always be modified identically corresponding to any changes to the cost driver. Average variable cost does not change based on modifications to the cost driver since the cost per unit should remain the same no matter the volume being produced. The total fixed cost remains set in stone, independent of the activity levels of production; they are not dependent on a cost driver. However, the average fixed costs are dependent on the quantity produced. Therefore, it begins to decrease as more units are created.

What is the best way to choose an appropriate cost driver when applying factory overhead?

To select an appropriate cost driver, the cost object must be established first in order to distribute cost amongst the object’s beneficiaries and allocating material handling expenses. It should be determined if there is a cost driver correlation between the processes and incurred expenses. Furthermore, a management control plan should be established to ensure the cost driver has a positive effect. The cost driver will vary based on the utilized production process, which would establish a rate based on either volume or activity. Some factors that should be considered include labor hours, labor costs, machine operating hours, resource expenditure, and technical costs.

What is activity-based management?

Activity-based management is an accounting tool used to evaluate the operational processes of an organization through the use of value-chain analysis. It can be used in decision-making since it presents the financial gains and weaknesses of a business by clearly outlining the solvency of each operational activity. This helps to determine any projects or parts of a company which is not profitable by analyzing associated costs such as payroll, infrastructure, equipment, and overhead factors.

Based on this evaluation, the areas of the business can be modified or eliminated. Data collected from an activity-based management analysis is used to develop budgeting plans and forecast models for the business. A critical weakness of this type of analysis is that it examines everything solely in monetary terms, devaluating potentially long-term or abstract benefits to a company.

What are the primary differences between job costing and process costing?

Job costing is an accurate and comprehensive collection of production expenses that are applied to specific units (or groups of units). This may include labor hours and pay, materials, and production costs, which can be used to create billing statements or evaluate company profits. Job costing is utilized for specialized and individual goods made in small-scale production runs.

Process costing is the accretion of expenses used in large-scale, long-term production operations. The produced goods are standardized and identical. Costs for all aspects of manufacturing are combined and divided by the number of produced components as a method to determine the cost per unit. Process costing has much simpler record-keeping procedures and does not produce billing that outlines specific manufacturing expenses since these types of projects are not commissioned by individual customers.

What is the difference between joint products and by-products?

During the manufacturing process in various industries, more than one product is created during or concurrently the production of the primary commodity. Joint products are created simultaneously using the same origin raw material and manufacturing process but eventually require individually specific refinement after separation to reach the result. Meanwhile, a by-product is formed during the manufacturing of the primary good and is nothing more than a subsidiary output. The key difference between joint and by-products is whether its creation was intentional or is a consequence of a manufacturing technique. Joint products are made from raw materials and have similar value in sale or utilization. However, a by-product is created from discarded material in primary manufacturing and usually has a significantly lower value.

What is operating leverage, and for what is it used?

Operating leverage is an indicator of the degree to which fixed or variable costs impact the operations of a company or project. Operating leverage is determined by dividing contribution margin by net operating income. It is helpful in determining the breakeven point of a company and formulates a pricing structure based on this analysis—high gross margins with low fixed and variable costs resulting in higher operating leverage. However, successful businesses do not increase costs based on better sales in order to maintain high leverage.

What is zero-based budgeting?

It is a mechanism of constructing a budget that starts at a zero point and is constructed based on the needs of an organization for the period. It is independent of previous budgets in both content and prices. Therefore, each project, department, or activity is evaluated during the budget-making process to determine whether it should be funded. It allows to implementation of strategic executive objectives by correlating their funding to specific functions within an organizational budget and measure costs against expectations. This type of budgeting process decreases expenses since there are no blanket changes to areas of a budget based on previous operational periods.

How do short-term evaluations affect a manager’s incentives and performance?

Short-term evaluations have the benefit of analyzing performance for a time that is less than fiscal periods or project due dates. This allows for correcting any deviations or errors before it has significant consequences on outcomes (such as project objectives or sales figures). Managers faced with short-term evaluations are more attuned to daily performance and seek to establish small goals that can be achieved by their team as an indicator of progress. Short-term assessments highlight factors of attitude and motivation, which can be corrected to ensure the necessary work is cultivated. However, if faced with oversight too often, managers may experience a decline in productivity and lose sight of long-term goals, focusing solely on “passing” the next evaluation.