Cost control is a series of steps that a business uses to maintain proper control over its costs. Implementing this level of control can have a profound positive impact on profits over the long term. The following four steps are associated with cost control:
- Create a baseline. Establish a standard or baseline against which actual costs are to be compared. These standards may be based on historical results, a reasonable improvement on historical results, or the theoretically best attainable cost performance. The middle alternative is generally considered to yield the best results, since it sets an achievable standard.
- Calculate a variance. Calculate the variance between actual results and the standard or baseline noted in the first step. Particular emphasis is placed on the detection of unfavorable variances, which are those actual costs that are higher than expected. If a variance is immaterial, it may not be worthwhile to report the item to management.
- Investigate variances. Conduct a detailed drill-down into the actual cost information to ascertain the reason for an unfavorable variance.
- Take action. Based on the information found in the preceding step, recommend to management whatever corrective actions are needed to reduce the risk of continued unfavorable cost variances.
The preceding steps are only recommended if a company routinely attempts to force its actual costs incurred to closely match its budgeted cost structure. If there is no budget, then an alternative way to practice cost control is to plot individual cost line items from the income statement on a trend line. If there is an unusual spike in the trend line, then the spike is investigated in relation to the average cost level, and corrective action is taken. Thus, operating without a budget eliminates the first two steps in the preceding list of activities, but cost control still requires investigatory work and recommendations to management for corrective action.
The shareholders of a publicly held company are particularly interested in a system of cost control, for they realize that tight cost control gives a company considerable influence over its cash flows and reported profits.