Monday, 2 January 2012

Adding Value - Effective Cost Management

Some costs are “value-adding” and others “value-destroying”. “Value-adding” costs are basically anything directly incurred in producing and/or supporting the product/service that brings in the cash.

“Value-destroying” costs are those that don’t add value. Businesses will have a mixture of each, and the trick is to minimise the destroyers. What you define as value-adders and destroyers depends on your business, but some examples of value-adders might be:

• Rent
• Rates
• Utilities
• Sales/production line salaries
• Raw materials
• Maintenance
• Staff training

“Value-destroying” costs might be:

• Time spent waiting
• Time spent checking
• Compliance costs (“red tape”)
• Correcting mistakes
• Fines/penalties

Small businesses frequently complain about the cost of “red tape” and its impact on their ability to do business. “Value-destroying” costs will never be eliminated. You have to pay the inspector who certifies your restaurant fit for business, otherwise you can’t do any business. This is a “bad” but “must have” cost. What you can do, however, is minimise your potential for incurring “value-destroying” costs such as waiting, checking, correcting mistakes or fines. These are the costs that arise from either inefficiency or errors and can be reduced or eliminated.

To find out your value-adding and destroying costs, ask yourself:

• “What do we do to produce our goods/services?"
• “What costs must be incurred to produce our goods / service?”
• “What are the values/standards on which we can’t afford to compromise?”
• “What can be done internally to reduce / control / eliminate mistakes?”
• “What will be the consequences (and can we live with them)?”

As much as possible, ensure that your costs are:

• Ones where the results can be seen;
Understandable in terms of what drives them and how;
• Ones that can be forecast with a relative degree of accuracy;

You have a potential problem if they are:

• Incurred in correcting mistakes.
Not quantifiable until "after the event".
Not measureable in terms of results, or if relationship to results is questionable.
Not understandable in terms of what drives them.
• Not always forecast with any degree of accuracy.
• Incurred by default.

A business manager, finance director or finance team must have this sort of information. Make sure that the finance team aren’t running the business just to make the numbers look nice, however. Their job is also to add value without sacrificing cash inflows.

I have spent more than half my life working in different world markets from the most developed to “emerging” economies. With more than 20 years in the world financial services industry running different service, operations and lending businesses, I started my own Performance Management Consultancy and work with individuals, small businesses, charities, quoted companies and academic institutions across the world. An international speaker, trainer, author and fund-raiser, I can be contacted by email . My website provides a full picture of my portfolio of services.

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