Al-Hamd Academy

Chapter # 25

COST MANAGEMENT Value Analysis

Value analysis is a group of techniques aimed at the systematic identification of unnecessary costs in a product or service and efficiently eliminating them without impairing its quality and efficiency. Initially the group of techniques, aimed at the systematic identification of unnecessary costs and exploring channels of performance improvement, was used mostly in the engineering field which gave it the name of value engineering, it is now used in the various areas of a concern such as marketing, purchasing, financing etc. By eliminating these costs; the cost of the product or service can be reduced, and the sales and the resulting profit proportionately increased. In value analysis it is possible to improve performance, increase the value of a product and thus reduce costs by a continuous process of planned action. Value analysis is sometimes taken as value engineering. There is no doubt that value engineering is an important aspect of value analysis and is concerned with production technology, product design, fabrication and quality control. Broadly speaking value engineering is mainly concerned with production while value analysis goes upto the marketing stage for the systematic identification of unnecessary costs and efficiently eliminating them. The scope of value analysis thus is broad and extends to all operations of an organization where cost is incurred.

Types of Value
The term, value is used in a broader sense and it has different meanings for different persons. For example, for a designer, value means quality of the product designed and efficiency of the product produced; for a salesman, it would be the price of the product at which it can be sold in the market; and for the management, value would be the return on capital employed. An industrial product may have the following types of value: 1) Use Value There are certain characteristics of a product which make it useful for certain purpose. Use value may be primary use value, secondary use value and auxiliary use value. Primary use value indicates the attributes of a product which are essential for its performance as engine, steering wheel and axle in a motor car without which car cannot run. Secondary use value refers to such devices as bonnet or the mudguard or the windscreen without which motor car can be driven but these are necessary for the protection of engine and other parts. Auxiliary use value it essential for better control and operation as speed meter, electric horn etc. in motor car. Esteem Value Certain properties of a product do not increase its utility or performance but they make it esteemable which would induce customers to purchase the product. For example, a watch with gold cover has esteem value. A rich customer may prefer a watch with gold cover although a watch with a steel cover may serve the same purpose of keeping time. Some products may have both use as well as esteem value and yet both may be important. For example, a fountain pen with a gold plated body will have both use and esteem value as it will not only look better but will also last longer.

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3) Cost value This value is measured in terms of cost involved. In the case of a manufacturing concern it refers to the cost of production of the product produced and if some part of the product is purchased from outside, it means cost of purchase of that part. Exchange value Certain characteristics of a product facilitate its exchange for something else and what we get is the exchange value of that product. It is equivalent to its sale value.

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Procedure of Value Analysis

The following points should be considered for putting a scheme of value analysis in operation: 1. Identification and definition of the problem, i.e. ascertaining whether the customer is being given the full use value and esteem value for the product he purchases and if not, what is required to be done. In case of raw materials and components performance, satisfaction in subsequent production or processes is to be seen. 2. The feasibility of the alternatives and exploring the best method of performing the work at the minimum cost. For this purpose all relevant facts like drawing and design, material specifications, material, labour, overhead and other costs, market competition etc. are considered before proceeding further with the job of value analysis. 3. The investment, if any, required for the alternative. 4. Percentage of the return on new investment. This return should be equal to or more than the expected return on investment. 5. Costs resulting indirectly out of a decision to change to alternative like costs of items becoming obsolete, cost of training, etc. 6. The benefits from the alternative like reduction in costs and increased revenue. 7. Recommendation of the final proposal for implementation after considering the above points which will increase use value or esteem value. Value analysis required a broad organizational framework, active involvement of various departments and a combination of initiative, creative approach, knowledge and mature personality in the person heading the value analysis team which generally includes a design engineer, a production engineer, cost accountant, system expert, market analyst and experts from other functional areas. For its success, the value analysis team should base its judgement upon complete information from all areas of the organization when cost is incurred, cost benefit analysis, work study, standard costing, market research etc.

Advantages of Value Analysis

The following are the main advantages of value analysis: 1. It is a powerful tool for cost reduction because its basic objective is the identification of unnecessary costs in a product or service and efficiently eliminating them without impairing its quality and efficiency. 2. It is a scientific tool for increasing the productivity of a concern because it aims at exploring various alternatives for efficient use of all types of resources in employment and making available goods and services of the kind and quality most wanted by customers at lower and lower costs. 3. It ensures the fullest possible use of resources because it aims at eliminating all unnecessary costs.

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4. It induces the creative ability of the staff because it involves a creative approach for finding out unnecessary costs. Creativity develops new ideas which, in turn, make available the least expensive alternative to do the same functions. It creates proper atmosphere for increased efficiency because it aims at a continuing search for improvement in efficiency. It can be applied at all stages from the initial design stage of an item right up to the final stage of its packing and desptach because it aims at identifying unnecessary costs at all levels with a view to eliminating them systematically. Customers needs are best served with the help of value analysis because it aims at production of the most suitable products. Management effectiveness can be measured with the help of value analysis because any saving in cost is treated as increased efficiency.

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Cost Control and Cost Reduction

Meaning of Cost Control
Managements are facing problems of survival because of acute competition. Only those organization can meet the competition effectively and have a hold on the market which are in a position to keep their cost minimum. Cost accounting can be instrumental in this regard by eliminating all inefficiencies and wastages by exercising cost control. Cost control aims at reducing inefficiencies and wastages and setting up predetermined costs and in achieving them. Cost control is exercised through setting standards or norms or targets and comparing actual performance therewith with a view to ascertaining deviations from set targets or norms or standards and taking corrective action to ensure that future performance conforms to the set standards or norms or targets.

Elements of a Cost Control Scheme

The following are the elements (i.e. major steps) of a cost control scheme: 1. Set down a norm or standard or target. 2. Select a yardstick for measuring the standard or target. 3. Ascertain the actual performance by applying the yardstick which was used for measuring the standard or target. 4. Compare the actual performance with the standard or target and compute the variances. 5. Analyse the variances by causes and fix responsibility of variances. 6. Take corrective action to eliminate the cause of variances so that future performance conforms to standards or targets laid down and cost may be controlled to achieve the maximum efficiency. 7. Periodically review the standards or targets and revise them in the light of changed circumstances.

Cost Control Techniques

Among the techniques which have become popular for ensuring cost control are: a) Material control b) Labour control c) Overhead control d) Budgetary control
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e) f) g) Standard costing Control of capital expenditure Productivity and accounting ratios

Essentials for Success of Cost Control

The following steps should be taken in an effective system of cost control: 1. For an effective system of cost control, the firm should have a define plan of organization. Authority and responsibility of each executive should be clearly defined. 2. Costs should be collected by each area of responsibility and reporting of efficiency or inefficiency displayed by each section should be prompt. Information delayed is information denied. If a considerable time elapses between happening of events and reporting, opportunity for taking appropriate action may be lost or some wrong decisions may be taken by management in the absence of information. 3. The report should draw managements attention to exceptionally good or bad performance so that management by exception may be carried out effectively. The aim should be to bring to light the factors leading to increase in cost rather than to punish people to take remedial action to improve the performance in future. 4. Good performance should be handsomely rewarded so that workers may be motivated towards better performance.

Meaning of Cost Reduction

Cost reduction is to be understood as the achievement of real and permanent reduction in the unit cost of goods manufactured or services rendered without impairing their suitability for the use intended. The definition given above brings to light the following characteristics of cost reduction: 1. The reduction must be a real one in the course of manufacture or services rendered. Real cost reduction comes through greater productivity. 2. The reduction must be a permanent one. It is short-lived if it comes through reduction in the prices of inputs, such as materials, labour etc. The reduction should be through improvements in methods of production from research work. 3. The reduction should not be at the cost of essential characteristics, such as quality of the products or services rendered. Thus, cost reduction must be a genuine one and should aim at the elimination of wasteful elements in methods of doing things. It should not be at the cost of quality. Cost reduction is a continuous process of critically examining various elements of cost and each aspect of the business (i.e. procedures, methods, products, management including market and finance etc.) is critically examined with a view to improving the efficiency for reducing costs.

Distinction between Cost Control and Cost Reduction

Cost control and cost reduction are two efficient tools of management but their concepts and procedures are widely different. The main points of differences between the two are the following: 1. Cost control aims at achieving the predetermined costs, whereas cost reduction aims at reduction of costs.

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2. Cost control is a routine exercise which is carried out for attainment of operational efficiency whereas cost reduction aims at permanent and real savings by continuous research. The process of cost control is to lay down a target, ascertain actual performance, compare it with the target and take corrective action. On the other hand, cost reduction is not concerned with maintenance of performance according to the predetermined standards. Cost control seeks adherence to standards whereas cost reduction is a challenge to the standards themselves. Cost reduction assumes that there are chances of improvements in predetermined standards.

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Areas of Cost Reduction

Cost reduction methods may be applied in the following areas: 1. Product Design Cost reduction begins with the improvement in the design of the product. Product design is the first step in the manufacture of a product and the impact of cost reduction effected at this stage is felt throughout the manufacturing life of the product. Factory Organization and Production Methods All efforts should be constantly made to reduce the costs by the adoption of new methods of organization and new production method. Factory Layout A cost reduction program should make a study of the factory layout to determine whether there is any scope of cost reduction by elimination of wastage of time, unnecessary effort and loss of money due to useless movement and travel of work in progress. Administration Office should be reorgzanised if there is scope for improvement in the efficiency of persons engaged in the office. Use of unnecessary forms should be avoided to save the cost of stationery and labour cost involved for compiling them. Marketing The various activities which can be brought under the cost reduction program include market research, advertisement, packing, warehouse, distribution, after-sales serve. Finance Management should be eliminate useless investment. To be able to do so, it must critically examine the amount of working capital and fixed capital needed and the financial conveniences of reducing them. Wasteful use of capital is as bad as inadequate capital. Fixed assets and inventories which cannot be economically used should be sold; the money realized from their sale should be reinvested in more profitable channels.

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Tools and Techniques of Cost Reduction

The various techniques and tools used for achieving cost reduction are practically the same which have been suggested for cost control. Some of these are: (i) Budgetary control; (ii) Standard costing; (iii) Standardization of products and tools and equipments; (iv) Simplification and variety reduction; (v) Improvement in design; (vi) Material
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control; (vii) Labour control; (viii) Overheads control; (ix) Production planning and control; (x) Automation; (xi) Operation research; (xii) Market research; (xiii) Planning and control of finance; (xiv) Value analysis; (xv) Quality measurement and research; (xvi) Cost benefit analysis.

Advantages of Cost Reduction

There are many advantages of cost reduction. Some of these are: 1. Cost reduction increases profit. It provides a basis for more dividends to the shareholders, more bonuses to the staff and more retention of profit for expansion of the business. 2. Cost reduction will provide more money for labour welfare scheme and thus improve men-management relationships. 3. Cost reduction will help in making goods available to the consumers at cheaper rates. 4. Higher profit will provide more revenue to the government by way of taxation. 5. As a result of reduction in cost, export price may be lowered which may increase total exports.

Dangers of Cost Reduction

The possible dangers of any cost reduction plan may be as follows: 1. Quality may be sacrificed at the cost of reduction in cost. To reduce cost, quality may be reduced gradually and it may not be detected till it has assumed alarming proportion. Quality may be reduced to such an extent that it may not be accepted in the market and the business may be lost to the competitors. 2. In the beginning cost reduction program may not be liked by the employees and danger may be posed to the program because success of any cost reduction plan depends upon the willing cooperation and active participation of the employees. 3. It is possible that reduction in cost may not be real and permanent, it may not be based on sound reasons and may be short lived and cost may come back to the original cost level when temporary conditions (i.e. fall in prices of materials) due to which cost has reduced may disappear.

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