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How can you identify areas of your cost structure that need improvement?

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If you want to improve your profitability and efficiency, you need to analyze your cost structure and identify the areas that need improvement. Your cost structure is the sum of all the fixed and variable costs that you incur to produce and sell your goods or services. By understanding how your costs behave and how they affect your margins, you can make better decisions and optimize your resources. In this article, we will show you how to identify areas of your cost structure that need improvement using four steps:

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Mattia Mucci

Treasury & Finance Manager

1 Benchmark your costs

The first step is to compare your costs with your competitors or industry standards. This will help you to see how you perform relative to others and where you have room for improvement. You can use various sources of information, such as financial reports, industry publications, trade associations, or online tools, to find relevant benchmarks for your costs. You should also consider the quality, features, and value of your products or services, as well as the size, location, and customer base of your business, when comparing your costs.

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Mattia Mucci

Treasury & Finance Manager
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To understand costs on which you have to focus the first step is to analyse the P&L statement and see which costs have an high impact on revenue. This preliminary analysis make you able to understand the controlling model you have to set up. The information source to make a comparable analysis are not always available, it depend on business sector. Sometimes you have to use single balance sheet of your competitor and sometimes you can have sector database with information of all companies.

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Roberto Villanueva

Nearshoring / Finance & Management Consulting/ Good to Great culture
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Any cost analysis has a challenging topic how information is presented and calculated Distribution of costs between direct and Indirect manufacturing including services provided for production are integrated different However create a timeline to make the cost development and behavior meaningful for your analysis At the bottom line production distribution sales and administration costs shows patterns for you to understand and find measures to implement

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2 Categorize your costs

The second step is to categorize your costs into different types, such as direct or indirect, fixed or variable, discretionary or committed, and essential or non-essential. This will help you to understand how your costs are related to your activities and outputs, and how they can be controlled or reduced. For example, direct costs are those that can be traced to a specific product or service, such as materials or labor, while indirect costs are those that cannot be easily allocated, such as rent or utilities. Fixed costs are those that do not change with the level of production or sales, such as depreciation or insurance, while variable costs are those that change proportionally, such as raw materials or commissions. Discretionary costs are those that can be adjusted or eliminated without affecting the core operations of the business, such as advertising or travel, while committed costs are those that are contractually or legally obligated, such as salaries or leases. Essential costs are those that are necessary for the survival and growth of the business, such as research and development or quality control, while non-essential costs are those that do not add value or can be substituted, such as entertainment or excess inventory.

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Roberto Villanueva

Nearshoring / Finance & Management Consulting/ Good to Great culture
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As stated before define your cost structure and establish a timeline so that you can define actions a and measure them Important to be able to split your type of Costa at product group or customer level

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3 Analyze your costs

The third step is to analyze your costs using various methods and tools, such as cost-volume-profit analysis, break-even analysis, margin analysis, variance analysis, or activity-based costing. These methods and tools will help you to measure the impact of your costs on your revenues, profits, and cash flows, and to identify the sources of inefficiencies, waste, or overruns. For example, cost-volume-profit analysis will help you to determine the level of sales that you need to cover your costs and earn a target profit, as well as the sensitivity of your profit to changes in price, volume, or cost. Break-even analysis will help you to calculate the point at which your revenues equal your costs, and the margin of safety that you have above or below that point. Margin analysis will help you to compare the gross profit, operating profit, and net profit margins of your products or services, and to identify the factors that affect them. Variance analysis will help you to compare your actual costs with your budgeted or standard costs, and to explain the reasons for the differences. Activity-based costing will help you to allocate your indirect costs to your products or services based on the activities that consume them, and to evaluate the profitability and efficiency of each product or service.

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Helena Lauchli, CPA, MACCT

Follow Me Through My Accounting Career
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To enhance cost analysis, employ diverse methods and tools like cost-volume-profit analysis, break-even analysis, margin analysis, variance analysis, and activity-based costing. These approaches enable a comprehensive evaluation of cost impact on revenues, profits, and cash flows. They also pinpoint inefficiencies, waste, or overruns. For instance, cost-volume-profit analysis determines the sales threshold for covering costs and achieving target profits, assessing sensitivity to changes in price, volume, or cost. Break-even analysis calculates the point where revenues match costs and reveals the margin of safety.

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4 Improve your costs

The fourth step is to improve your costs by implementing various strategies and actions, such as cost reduction, cost avoidance, cost shifting, or value analysis. These strategies and actions will help you to lower your costs, prevent future costs, transfer costs to others, or increase the value of your products or services. For example, cost reduction can be achieved by eliminating waste, improving processes, negotiating with suppliers, or outsourcing non-core activities. Cost avoidance can be achieved by preventing errors, defects, or rework, avoiding penalties, fines, or lawsuits, or postponing or canceling unnecessary expenditures. Cost shifting can be achieved by passing on costs to customers, suppliers, or partners, or by changing the timing or frequency of payments. Value analysis can be achieved by enhancing the quality, features, or benefits of your products or services, or by reducing the costs that do not contribute to customer satisfaction.

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5 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?

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How can you identify areas of your cost structure that need improvement?

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1 Benchmark your costs

2 Categorize your costs

3 Analyze your costs

4 Improve your costs

5 Here’s what else to consider

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