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Reducing internal cost of businessand goods

Abstract

Businesses are faced with a number of challenges some of which can easily be solved through adoption of better organisational systems and methods. One main challenge that must be faced and overcome by small businesses involves cost control and reduction. Business costs can be classified into the following different categories; direct and indirect, fixed and variable, opportunity and lifecycle costs with  common ways of cost reduction including: outsourcing, waste management, operation efficiency, supplier chain integration, profitability and feasibility analysis, and improving organization security. This study is directed towards studying the various alternatives that may be used in reducing internal costs which greatly contributes to higher profitability of the small business and maintaining competitiveness in the market.

Businesses are faced with a number of challenges some of which can easily be solved through adoption of better organisational systems and methods. Small businesses owing to their small capital bases are more at risk of failing if some of their challenges are not adequately resolved. One main challenge that must be faced and overcome by small businesses involves cost control and reduction.

Cost reduction for both small, medium sized and large organizations is geared towards achieving two main objectives; to increase competitiveness under the prevailing economic climate and to maximise business profitability. The implications of failing to implement cost reduction measures are far reaching and could easily lead to the eventual closure of the business as a result of incurring losses which can be avoided or minimised.

This study is directed towards studying the various alternatives that may be used in reducing internal costs which greatly contributes to higher profitability of the small business. The study will perform an in depth analysis of various costs that are incurred by businesses, and the different methods that have been used in the past to adequately tackle this challenge. Further, recommendations will be made towards ensuring that the small business achieves better status in terms of cost reduction.

The result of this study can be applied by both big and small businesses, but more emphasis is directed to the small business, to reduce internal costs and overall costs of goods.

2.0 Literature Review

In business, economics, accounting or retail, cost is the amount of money that is expended during the production of goods or services (Bouknight & Scott, 2007). This implies that once the cost is incurred, the money is no longer available for business use. Cost can also be an alternative that is foregone as a result of taking another, usually better, alternative. Yet another description of cost is the value of money expended in acquiring goods, supplies, equipments, labour or other services.

2.1 Classification of business costs

Classification of business costs is important in ensuring that accounting for profits and losses are accurately done as well as for easy performance of break even analysis. In order to determine how much the business must produce and cater for its costs without making a profit or loss, a break even analysis is conducted which also gives a good estimate of how much each unit product costs. Business costs can be classified into the following different categories: direct and indirect, fixed and variable, opportunity and lifecycle costs.

The following section is dedicated to the study of the various costs that are incurred by businesses during their operations:

2.1.1 Fixed and variable costs

Variable costs continuously change in proportion as the amount of output changes while fixed costs remain constant regardless of how much production is undertaken. In a typical business, variable costs will include workers wages, cost of energy and cost of raw materials. Fixed costs on the other hand will include rent, heading and lighting, salaries of permanent employees, loan interests and insurance.

2.1.2 Direct, indirect, lifecycle and opportunity costs

Direct costs are those that can directly be attributed to the production of a service or good such as raw materials. Indirect costs are those costs which cannot be directly matched against every product since they are incurred whether or not production of goods and services is accomplished such as payment of rent. Life cycle costs are the total costs that are incurred in the cost of conducting business. An opportunity cost is the cost of foregoing the next best alternative expenditure as a result of decision taken.

2.2 Cost control and reduction

Cost reduction and control are efforts that business entrepreneurs exert to evaluate, monitor and minimize expenditures. Efforts to minimize costs may be taken informally by individuals or formally by the entire organisation or a particular department. Whichever the case, cost reduction and control is important for big and small businesses.

While large businesses may not be affected significantly with minor expenditures such as telephone bills, overnight delivery services and office supplies, this is not the case with small businesses which can greatly be affected by such costs. General consensus has it that even minor expenditures can greatly contribute towards great savings over a period of time.

2.3 Planning and cost control

Business managers have a duty of influencing the actions of people responsible for doing certain tasks, generating revenues and incurring costs. Managers develop plans that are to be followed complete with implementation procedures which they constantly must review to determine how compliant are the activities being performed with the plan.

Cost control is a process that should be carried out continuously beginning with the development of an annual budget/plan. With the year’s progression, actual results and those projected according to the budget are compared and lessons learnt from evaluations are integrated into the current business’ operations.

Planning of business processes allows for control mechanisms that allow management to receive feedback which is important in control of business processes and employee activities after implementation of an initial plan.

2.4 Control reports

The business requires monitoring its performance continuously. This is accomplished when records are reviewed to come up with new ideas that will further help the business make progress. Businesses can use records to evaluate the utilization rate of almost all their resources and track developments that result from decisions made by the management on all issues.

2.5 Cost Cutting for Small Businesses

No department in the organisation is exempted from engaging in activities that will lead to the objective of maximising profits and staying ahead of competition. Quite a number of techniques can be used to enable small businesses to achieve cost reduction.

2.5.1 Human Resources and Outsourcing

However technologically advanced a business organisation may be, it needs a human resource to run successfully. Business management should employ a human resource that is competent enough to run the company at the lowest reasonable cost (Kaplan and Norton, 1996). The number of employees must be maintained at minimum and wherever applicable temporary staff used. Businesses may sometimes have to cut down its human resource as a result of several reasons but with a main aim of keeping costs at minimum.

Many times businesses have to employ and pay several workers to perform tasks that could be done more efficiently by other organisations at more affordable rates (Ciaran, 1987). This may involve hiring an external consultant or analyst who has the capacity to perform certain functions more efficiently and a lower cost than what the organisation would incur if it were to perform the task itself. The main benefits of outsourcing are as follows: The business person saves time, is able to negotiate more favourable contracts with suppliers and vendors, and raises awareness of business costs.

2.5.2 Waste management

During production or manufacturing, wastes are produced which increase the unit and by extent the overall cost of production. Wastes in many cases may result from time wasting, overproduction, over processing, scrap, unnecessary motion, transportation and excess inventory (Kaplan & Norton, 1996). In the manufacturing setup, the term lean manufacturing is applied to suggest a process of working with minimum costs to achieve high levels of production. At all costs, businesses must avoid wastage of time, inventory human and other resources.

2.5.3 Operation efficiency

According to PricewaterhouseCoopers, today’s business environment is fragmented and highly competitive. This calls for absolute customer focus and market-driven orientation for business to succeed (2002). Failure to do this will lead customers to choose to give other businesses attention.  In this respect, businesses must be fully committed, focusing attention to customer views and demonstrating actively understanding and willingness to meet customer demands.

Technology cuts across all business units, industries and business functions. Selecting the appropriate technology enables business processes to be undertaken efficiently and cost effectively. Organisations need to be agile and adopt the most efficient and cost effective ways of performing all tasks.

Process is known to be core to cost reduction for repetitive activities (Prichard & Jordan, 1999). Operation efficiency also goes beyond utilisation of current technologies to include proper use of inventory and business services. It is clear that by increasing production levels and maintaining overall costs leads to an overall reduction on production costs. It is hence logical to employ techniques that will result in increased productivity.

2.5.4 Supplier cost reduction

Suppliers play an integral part in the success of a business. Good suppliers will contribute significantly to business progress by providing supplies both in time and at competitive rates (Michael, Leyland & Earl 2001). It is in this respect that many businesses establish strong supply chain systems that boost their chances of success.

2.5.5 Profitability and feasibility analysis

Economic feasibility analysis involves determining savings and benefits that will accrue to the business when it adopts a system and comparing these with costs of establishing or adopting the system (Michael, Leyland & Earl 2001). Small businesses should perform profitability and feasibility analysis before adopting new systems, procedures and methods to ensure that the cost/benefit ratio is as low as possible (Pass & Lowes 1994). In other words, it is only reasonable for business enterprises to make investments that will be rewarding over a reasonably long period of time.

2.5.6 Security

Loss prevention is very important for all businesses. Losses may result from natural and uncontrollable factors such as earthquakes and floods, but more common as a result of human action (Wright & Race 2004). While insurance plays a great role in cushioning the business against some losses such as fire accidents, and theft but at a great cost.

Improving the general levels of security within the business premise is one way by which businesses reduce cost especially by reducing or eliminating chances of the occurrence of theft by employees and outsiders. Theft in most cases necessitates replacement of the stolen item which increases the overall cost of production.

3.0 Methodology

The study was performed by observing the processes, procedures and ways by which a number of small businesses conduct their business activities. A random sample of ten small businesses was taken cutting across all industries including retail shops, small service industries and manufacturing industries. Questionnaires were used in the survey to determine which ways small organisations can use for internal cost reduction.

In order to make the survey simpler to implement, the questionnaires were designed to focus on nine key business areas: Billings and Receivables, General Management Control, Procurement and Payment, Cash Management, Expenditure and Expenses, Inventory Management, Human Resources, Information and Production Technology, and Financial Accounting and Management.

The respondents were required to list ways or methods by which they reduce costs in the various categories as shown in the table below. Respondents were instructed to note down as many ways of cost reduction as possible not considering that the questionnaire presented five blanks ton be filled per department.

Table 1 Control measures adopted by various departments of small business organisations.

Business Areas Under Scrutiny
Cost Control/Reduction Measures
1
2
3
4
5
Billings and Receivables

General Management Control

Procurement and Payment

Cash Management

Expenditure and Expenses

Inventory Management

Human Resources

Information and Production Technology

Financial Accounting and Management

4.0 Results

According to the data collected, it is realised that different organisations use various means to towards cost reduction and control. Some of the observed measures are similar and cut across most organisations. In general, cost of service delivery is maintained as low as practicably possible by the different organisations depending on whether they are service oriented, manufacturing or trade merchandise. Most organisations base their employee wages based on market norms.

Supply chain integration, lean production and adoption of efficient operational systems were found to be key elements applied in cost reduction.

5.0 Conclusions and Recommendations

While conducting research is of great value, greater value is achieved when action is taken in line with the results of the survey. From the analysis carried out, it is realised that reduction of costs can be achieved even by small businesses across all sectors of the economy and specific organizational departments.

Every business must recognize the urgent need to reduce costs. Small businesses especially must recognize the risk posed by high costs incurred in the course of doing business. Instead of employing cost cutting in the face of crises, it should be embraced as a strategic issue and approached from the market perspective.

The following recommendations are therefore made to enable the small business cut on costs that are associated with production:

As much as possible photocopy or print on both sides of paper if the condition so allows.
All supply cabinets and stores should be kept locked as and whenever necessary to prevent losses that may result from theft.
All insurance on unused vehicles and equipment (that are not beneficial) should be cancelled.
The business owner should make a review of costs from various suppliers and shop for individual products from the most competitive suppliers.
Buy goods in bulk and negotiate for discounts and price reductions as much as possible.

List of References

Bouknight O and  Scott S 2007 Your MBA Game Plan Proven Strategies for Getting into the Top Business Schools Edition revised Published by Career Press

Ciaran D 1987Towards Full Employment a Policy Appraisal Edition illustrated Published by Routledge

Kaplan S and Norton P 1996The Balanced Scorecard: Translating Strategy into Action Norton Edition illustrated Harvard Business Press

Michael H. Leyland F and Earl D 2001 Business to business marketing a strategic approach Edition 3 revised illustrated SAGE

Pass L and Lowes B 1994 Business and Microeconomics: An Introduction to the Market Economy Edition illustrated Routledge

PricewaterhouseCoopers 2002 Internal Audit Cost Reduction  Efficiency Improvement Reviews http://www.pwchk.com/home/eng/ia_costreduction.html

Prichard J and Jordan L 1999 Maximising performance in insurance operations

Woodhead Publishing

Wright J and Race P 2004 The management of service operations Edition: 2, illustrated Cengage Learning EMEA