In earlier articles on the roles of finance, one of the more routine exercise is to review the company’s cost base with the objective of conducting costs cutting exercise to at least align to the revenue generated.

However, a very interesting question arises before we can do anything on the costs. Are we performing a cost reduction/cutting exercise or are we looking at cost effectiveness exercise? For some financial specialists, the term cost reduction/cutting is synonymous with Cost Effectiveness or Cost Awareness.

This Part 1 of a series of article is to put right the correct perspective of the aforesaid terms commonly used. Using the word “cost cutting” might be quite disastrous when such words like cost effectiveness would suffice.

Its important to understand that mere cost reduction or cutting is not the same as costs awareness or effectiveness.

Cost effectiveness is the balancing of spending wisely to get the most effective return on our company assets. It is not cost cutting, but is essentially the principle of getting the right financial returns on assets and resources deployed. There is always the constant challenge to spend where necessary/wisely and where we must get the most optimum and effective financial and non financial returns. In simple terms, it is more towards working smart and maximizing the results with the resources deployed.

Some typical cost effectiveness examples include the following:

• Elimination of non value adding processes
• Elimination of layers of activities
• Maximize technology
• Maximize the returns on investment on events/programmes that can positively to the company’s bottom line.

Whereas if we were to do a simple Cost Cutting, we tend to:-

• Cut cost and in the process ignore giving best quality services level to our customers and  compromising quality. Cost cutting if improperly executed might lead to “Penny-wise Pound foolish” reactions.

For cost effectiveness we constantly ask ourselves the following:

• How wise have we spent company’s money,
• Are we doing it because in the past others have always done this way;
• Why are we spending the money;
• What are the objectives that are to be realized by spending the money;
• If it is our money, would we want to spend it this way? Would we want to spend it more wisely;
• Remember, for every RM1 we spend, we need to generate sales of X dollars to have the cash available which therefore is very hard earned money;
• The need to plan and anticipate ahead;
• Drilling into details to understand better;
• This might involves simplifying the whole procedure/process as the present process has too many cost layers or which were set up in the past and times have changed;
• Asking for the bigger picture.

In view of the foregoing, do be careful, when you use terms like cost reduction or cost effectiveness in front of your other senior operating managers.

In the next article let’s look at the basic steps/procedures to conduct such a cost awareness or effectiveness exercise.

If you found this post useful, keep updated with future posts by subscribing to FMAccounting (for free) through RSS or email.

Related Entries

• Cost Reduction/Awareness/Effectiveness – Suggestion KPI ( Part 3 of 4)
• Steps/Procedures In A Costs Awareness/Effectiveness Exercise ( Part 2 of 4)
• Credit Management:What is the KPA and KPI of a Credit Manager?
• KPA/KPI: Identifying Your “Customer”
• Characteristic Of Warrants And Its Technical Jargon