Types of Cost Reduction
When working for a company that takes cost reductions seriously, we can expect to see some categories repeated. Let’s take a look at these and what they are:
- Cost reduction: we spend less on a line item than our budget
- Cost avoidance: we choose to spend and then decide not to (often occurs with capital expenses)
- Profit improvement: we sell something
- One shot sale of surplus equipment
- Regular “garage” sales
- Myth: floor space, for example. Floor space is only significant in terms of cost savings if we shut down utilities to a closed area or we rent or sell the space.
Our accounting department prefer true cost reductions followed by profit improvements (make sure we don’t distort depreciation!). Cost avoidances are generally not considered to be savings, even when they appear in a capital budget. However, we suggest that validated cost avoidances are a sign of good stewardship—sometimes our needs change between the time we specify the capital expense and when spending comes nigh.
Regardless, we feel that cost reductions are the duty of any firm that wants to survive.