Cost Avoidance vs Cost Savings:

What’s The Difference?

Cost Avoidance vs Cost Savings: What’s

The Difference?
In business, taking action to keep costs down and avoiding spending more money
than you need to is just smart. The more you can keep in revenue and cash flow,
the better your profits will be. However, in some businesses, you may hear the
phrases “cost avoidance” and “cost savings” used interchangeably. The reality is
the two phrases have different meanings, and understanding how they differ can
make a big difference in overall business operations.

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What is Cost Avoidance?
Cost avoidance focuses on actions that avoid incurring costs in the future. In
business, this means taking measures to lower potential increased expenses so
that a company doesn’t have as many costs in the future.

With cost avoidance, all actions are taken to reduce future costs. For example,
spending money regularly to properly adhere to maintenance schedules on fleet
vehicles and equipment is a cost avoidance strategy. Failure to address
maintenance and keeping everything in good working order could lead to needing
to make more expensive repairs or replacements in the future. Letting employees
operate vehicles and equipment in poor conditions could also increase the chance
of an accident which would go far behind the cost of simply repairing the vehicle.

Anything that is a preemptive action to avoid prospective cost increases in the

future is cost avoidance. It’s not something you can see or measure in an
organization’s budget or financial statements.

Because cost avoidance measures may require spending money as a temporary

additional cost, in the short run, expenses may appear elevated. However, the
additional amount of money now serves to lower costs in the future, ultimately
bringing the total cost down.

Let’s say a company is planning to increase sales volume by entering markets in

new geographic areas beyond the corporate headquarters. It’s possible the
company currently doesn’t have the sales team that could support the plan. In this
situation, the company may opt for incremental spending to increase its
salesforce with additional staff. Or, the company may make a one-time investment
to purchase the latest technology to allow its sales force to work from home,
spending more time in the field.

Investing in new technology is the winning choice because it eliminates spending

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on compensation costs now and in the future.

Another example of cost avoidance is to look for value-added services. These

services are available at little or no cost to the business, but help it in the long
run. For instance, when a company purchases those fleet vehicles, the dealership
may offer an extended warranty, or free oil changes for the life of the lease, etc.
that saves the business money in the long run. Making an effort to keep service
costs down improves indirect spending.

Cost avoidance means not having to spend money in the future. Cost savings
reflect the money you didn’t have to spend on something now.

Hard and Soft Costs

Hard Costs
Hard costs refer to the purchasing price of hard assets. It’s a direct cost, typically
any tangible asset, that holds some kind of intrinsic value. For example,
purchasing inventory, equipment, facilities, or land is all considered hard costs. A
hard cost is easy to estimate because the cost is as-is when it is incurred.

Soft Costs
Soft costs are those that are associated with intangibles. They are indirect costs,
including legal costs, accounting, banking, and so on. They are more difficult to
quantify because they are difficult to forecast. Growth in soft costs may be a part
of keeping a project going successfully until it is finished.

Soft saving is the “intangible benefit of continuous company improvement.” Soft

savings cannot be seen on invoices, receipts, or financial records. They are
reflected in capacity enhancements and in cost avoidance measures. Examples

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include improving workplace safety, better employee satisfaction, better customer
satisfaction, compliance with changes in legislation, and reducing the need for
working capital.

Cost Savings
Unlike cost avoidance, cost savings are reflected in both the company budget and
financial statements. Cost savings can also be referred to as “hard savings”, and
associated with actions that reduce debt levels, current spending, or investment.
An organization’s buffet and financial statements should always highlight any
savings achieved through cost savings. Planned cost savings should be part of the
budget, too. Cost savings in comparison to previous periods should also be added
to financial statements, so the company effectively measures cost savings in
regard to profit over the year.

Cost saving measures refer to any action that produces tangible financial benefits
reflected in the company budget and financial statements.

Example of Cost Savings

Partnerships
Partnerships help companies reduce their costs. Partnering with a cloud service
provider, for example, eliminates the need to build and maintain a computing
infrastructure on-premise.

New Contracts and Contract Renewals

Each time a contract is negotiated, either as the initial contract or renewal,
there’s potential for cost savings. Whether it is from a reduced overall price for a
longer contract or through value-added services, procurement staff can work with

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potential vendors to get the best possible deal. Contracts can help you avoid price
increases in the long run by locking in a discount for several years.

Price Negotiations
This is another area where procurement can make a huge difference in the overall
budget. For instance, if you’ve been buying a fixed amount of something, but need
to increase volume, you may be able to negotiate with the vendor to get a lower
price per unit. When the procurement department is able to lower current
spending with a new price, reflect that in next year’s budget.

Calculating Cost Savings

Original Price
Determine the price of the product or service that you are potentially saving from.
It is the original price you use throughout the rest of the calculations.

New Price
Next, turn the new price of the product or service that you will be saving from.
This is the price after a sales promotion, discount, deal, or after negotiation.

Price Difference
Next, determine the difference between the original price and the new price.
Subtract the new price from the original price.

Division
Divide the price difference by the original price.

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Cost Savings Percentage
Multiply the price difference by 100 to get the percentage, which is your cost
savings percentage.

Maximizing Cost Savings

Reducing Marketing Costs
Thanks to social media and search engines, both paid and unpaid advertising can
reach millions of people in a fraction of the time and cost it used to take. Working
with social media professionals can help you market your business without
needing to hire a full marketing agency, so you save money and improve your
returns.

Outsourcing
Outsourcing opens your company up to talent from all over the world and can be
useful to fill roles that you need on a part-time basis. There’s no reason to hire an
in-house writer for a few blog posts every week and pay them a salary, but having
a current employee write the content may mean work suffers elsewhere. Instead,
working with a freelancer keeps your overall costs down and ensures your
employees are working on tasks they enjoy and excel at.

Technology Investments
Technology can decrease operational costs and maximize cost savings. Evaluate
your organization’s current administrative processes and make process
improvements where possible. Look for areas that can be automated with
technology. Keeping current with the latest technology keeps you competitive and
has the potential to significantly reduce operational costs.

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Reducing the daily manual efforts your employees must make improves
productivity because they can focus their efforts on other valuable tasks. Not only
this, but you can produce cost savings by reducing the time and money wasted as
a result of human error.

What’s your goal today?

1. Use PLANERGY to manage purchasing and accounts
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