COST MANAGEMENT

Cost management is the process of planning and controlling the budget of a business. Cost
management is a form of management accounting that allows a business to predict impending
expenditures to help reduce the chance of going over budget.

Crossing all functional areas, a cost management system can be viewed as having six primary
goals:
(1) develop reasonably accurate product costs, especially through the use of cost drivers
(activities that have direct cause-and-effect relationships with costs);
(2) assess product/service life-cycle performance;
(3) improve understanding of processes and activities;
(4) control costs;
(5) measure performance; and
(6) allow the pursuit of organizational strategies.

A cost management system (CMS) consists of a set of formal methods developed for planning
and controlling an organizations cost-generating activities relative to its short-term objectives
and long-term strategies. Business entities face two major challenges: achieving profitability in
the short run and maintaining a competitive position in the long run. An effective cost
management system must provide managers the information needed to meet both of these
challenges.

Information requirements for organizational success in the short run and long run. The
short-run requirement is that revenues exceed coststhe organization must make efficient
use of its resources relative to the revenues that are generated. Specific cost information
is needed and must be delivered in a timely fashion to an individual who is in a position to
influence the cost. Short-run information requirements are often described as relating to
operational management.

Meeting the long-run objective, survival, depends on acquiring the right inputs from the right
suppliers, selling the right mix of products to the right customers, and using the most
appropriate channels of distribution. These decisions require only periodic information that
is reasonably accurate. Long-run information requirements are often described as relating to
strategic management.
The information generated from the CMS should benefit all functional areas of the entity. Thus,
the system should improve the quality, content, relevance, and timing of cost information that
managers use for short-term and long-term decision making.

First and foremost, a CMS should provide the means to develop accurate product or service
costs. This requires that the system be designed to use cost driver information to trace costs
to products and services. The system does not have to be the most accurate, but it should match
benefits of additional accuracy with expenses of achieving additional accuracy. Traceability has
been made easier by improved information technology, including bar coding.

NEED OF COST MANAGEMENT

The purpose of cost management is to ensure adequate supply of funds from the right source at
the right cost and at the right time to the firm to meet its funding needs. In this connection a cost
benefit analysis of various alternative sources must be made before acquiring funds from any
particular source. Financial activities have undergone tremendous changes, the cost management,
therefore gained much importance over the time.

SIGNIFICANCE OF COST MANAGEMENT

Determinant of Business Success- Sound cost management is the index of the success of an
enterprise, its existence and growth. Cost management makes possible the use of available
resources in the form of men, materials and machines more effectively. Thus, it helps in
preparation of plans for development & expansion and their successful executions.

Focal point of Decision making- It provides scientific analysis of facts and figures. This helps on
evaluating the profitability of the project in the given circumstances so that a proper decision
may be taken to minimize the risk involved in the project.

Measurement of performance- The performance of the firm can be measured by its financial
results i.e. by the size of its earnings. Risk and profitability are two major factors which jointly
determine the value of the firm. Financial decisions which increase the risk will reduce the value
of the firm, and on the other hand, financial decision which increases the profitability will
enhance the value of the firm. Therefore, risk and profitability are two essential ingredients of a
business concern as observed, financial decision affect the size of earnings stream or profitability
and the riskiness of the firm. Policy decision affects risk and profitability.
Advisory Role- It plays a very important role in the success of a business organization by
advising top management. It represents important facts and figures regarding financial position
and performance of various segments of the firm to evaluate the progress of the firm and to
amend suitably the principles of the firm.

Optimal Utilization of Resources- Sound cost management emphasizes the optimum utilization
of resources of the enterprise. In fact, the failure of a business enterprise is not always the result
of inadequate finance but it is the result of defective management of funds. Effective cost
management plays the important role in the maximum exploitation and utilization of the
enterprise resources. Effective utilization of financial resources is of great significance. It gives
maximum returns by increasing the productivity of capital funds.

OBJECTIVES OF COST MANAGEMENT

The main objective of cost management is to reduce the costs expended by an organization while
strengthening the strategic position of the firm. Three ways to institute cost management
techniques.

Establish systems to help streamline the transactions between corporate support

departments and the operating units.
Devise transfer pricing systems to coordinate the buyer-supplier interactions between
decentralized organizational operating units
Use pseudo profit centers to create profit maximizing behavior in what were formerly
cost centers.