Analysis of Cost: Using Quantitative Analysis to Manage and Control Business Costs

Understanding and managing costs is essential for business success in today's data-driven world. Cost analysis stands at the heart of managerial accounting, providing a competitive edge with crucial insights into a company’s finances, operations and market conditions. Through quantitative analysis, businesses can gain a clear picture of their expenditures. This knowledge lets managers control business costs effectively and make informed financial decisions. In this blog, we will explore the foundations and applications of cost analysis, highlighting its significance in existing operations and new ventures.

Understanding managerial accounting and cost analysis is fundamental to making wise financial decisions and running a successful business. Let’s look more closely at these two essential concepts.

Managerial accounting is an internal business function that provides managers with the financial data they need to make informed decisions. Unlike financial accounting, which uses historical data to provide external stakeholders with standardized financial information about a company's performance and financial health, managerial accounting provides information support for management decision-making. This information helps with budgeting, strategic planning, and controlling business operations.¹

Cost analysis is the systematic process of examining and identifying the costs associated with a product, service, process, or investment. It involves classifying costs, understanding cost drivers, and using this information to make informed decisions about resource allocation, pricing strategies, cost control, and profitability improvement.

By employing quantitative analysis, businesses can gain insights into direct costs, such as labor and materials, and indirect costs, such as utilities and administrative expenses. Cost analysis can be used in various ways, such as calculating the break-even point for new products, assessing net present value for investments, and optimizing value engineering for existing products.

Cost analysis plays a pivotal role in managing existing products and processes. Businesses can identify opportunities for cost reduction and efficiency improvements by thoroughly examining costs. This analysis considers fixed expenses like rent and salaries and variable costs like raw materials and production supplies.

Effective cost control starts with a thorough understanding of existing expenses. Companies can deploy various strategies to manage and reduce costs. For instance, value engineering can optimize product design to lower production costs without compromising quality. Cost analysis can also help a project manager pinpoint inefficiencies and bottlenecks within existing processes to support process improvement efforts.

Analyzing material costs can reveal opportunities for bulk purchasing discounts, negotiating with suppliers, or exploring alternative materials. Similarly, analyzing labor costs might suggest options for improving worker efficiency, optimizing staffing levels, or outsourcing certain tasks.

Understanding the distinction between direct and indirect costs is crucial. Direct costs can be directly tied to producing goods and services, such as raw materials and labor. On the other hand, indirect costs are not directly linked to production but are necessary for running the business—examples include utilities and administrative expenses. By analyzing both types of costs, companies can gain a comprehensive view of their expenditures and identify areas for improvement.²

Activity-based costing is a core concept in cost management. It refines costing accuracy by assigning costs to products and services based on the activities required to produce them. This approach provides a more precise understanding of indirect costs by linking them to specific activities. ABC is beneficial for identifying high-overhead areas and optimizing processes to control costs. By leveraging ABC, businesses can make informed decisions on cost reductions and improvements, ultimately driving profitability.³

Introducing a new product involves substantial financial commitment. Cost analysis is critical in this scenario, enabling businesses to estimate and manage costs effectively. By performing a comprehensive cost analysis, companies can determine whether a new product will be financially viable and align with their strategic goals. Several quantitative tools can assist in evaluating the potential success of new offerings:

A cost-benefit analysis expands the scope to evaluate a new venture's overall impact. This broader analysis considers expected benefits, such as increased sales, improved efficiency, or market share gain, to provide a more comprehensive picture of the potential value of the new product, process, or investment.⁴

Break-even analysis determines when a new product will become profitable—where total revenue equals total costs—helping businesses understand the sales volume needed to cover initial investments and ongoing operational costs.

The hurdle rate is the minimum acceptable rate of return on an investment. It serves as a benchmark to assess whether a project should proceed. The project can be deemed acceptable if the expected return on investment meets or exceeds the hurdle rate. Incorporating the hurdle rate in the cost analysis process ensures that investments align with the company’s risk tolerance and financial goals.⁵

Here's an example of how a company would use these tools to explore the viability of a proposed new software product. It could begin with estimating the project costs for development and then identifying the break-even point. The following steps include deriving an appropriate discount rate for future cash flows, determining the net present value of that income, and determining if the expected return meets the hurdle rate. A business can make informed decisions and avoid costly missteps by employing such a rigorous cost-benefit analysis process.

Capital investments involve substantial outlays of cash and resources, often with long-term implications for a business. Examples of capital investments include purchasing new equipment, expanding facilities, entering a new market, or upgrading technology infrastructure. Conducting a thorough cost analysis of these investments is crucial to ensure that the benefits outweigh the costs and align with the organization's strategic objectives.

Business leaders and project managers should consider fixed and variable costs, maintenance costs, estimated versus actual costs, and opportunity costs in any cost analysis, and these analyses have particular relevance in the context of capital investments.

• Fixed and Variable Costs: Capital investments often entail significant fixed costs, such as the purchase price of equipment, the cost of financing, or construction costs. Variable costs, like maintenance and operation expenses, can fluctuate and impact the overall profitability of the investment.
• Maintenance Costs: The long-term success of a capital investment depends on ongoing maintenance. These costs must be factored into the initial analysis to provide a realistic picture of the investment’s viability.
• Estimated vs. Actual Costs: Dynamic market conditions can cause actual costs to differ from the estimated costs. Budgeting contingencies is essential to account for potential discrepancies and avoid budget overruns.
• Opportunity Cost: Investing in one project means potentially forgoing other opportunities. Understanding the opportunity costs is vital in ensuring that the chosen investment aligns with strategic goals while providing the highest benefit-cost ratio.

When evaluating capital investments, a cost-benefit analysis is essential. Businesses can determine whether the investment will generate sufficient returns by quantifying the anticipated costs and benefits. This method also considers intangible future benefits like enhanced brand reputation or improved customer satisfaction.

Conduct a net present value analysis to understand the value of expected future cash flows generated by an investment, discounted back to the present value. A positive NPV indicates that an investment will likely be profitable and worth pursuing.⁶

The discount rate used in NPV analysis is derived from the required rate of return (hurdle rate), reflecting the investor's risk and opportunity cost of capital. It is used to determine the present value of expected future cash flows.⁷

Like the discount rate, the internal rate of return (IRR) represents the expected annual percentage return on an investment. Comparing the IRR to the company’s hurdle rate helps determine if the investment meets the minimum required return. If the IRR exceeds the hurdle rate, the investment is considered acceptable.⁸

The payback period measures the time it will take for an investment to generate enough cash flow to recoup the original investment. While it doesn't account for the time value of money, it offers a straightforward assessment of the investment's risk and liquidity.

For instance, if a company is considering purchasing new manufacturing equipment, it would perform a comprehensive cost analysis to estimate the expenses involved, including purchase price, installation, and maintenance. After conducting a cost-benefit analysis, calculating the NPV and IRR, and assessing the payback period, the company can consider qualitative factors and compare the proposed project against other possible investments to make data-driven decisions on which investments to make.

In today's dynamic business environment, success hinges on finding and acting on the right opportunities among many choices. The skills gained from Seattle University's Online MSBA program prepare graduates to excel in this area, enabling them to navigate complex data and make strategic decisions that drive business success. Two essential courses stand out in this regard:

This course equips students with the methodologies to use data for improved decision-making and performance. It emphasizes real-life business decisions and real-data modeling frequently used in the industry. You'll learn how to conduct business valuation, understand investor reactions, and make better financial decisions based on thorough data analysis.

In this course, you'll explore how to apply data analytics methods to traditional management and marketing challenges. Effective stakeholder management is crucial for realizing business value, and this course helps students think critically about using data to enhance these relationships. Poor data handling can negatively impact organizational outcomes, making these skills invaluable.

These courses prepare students to tackle cost analysis tasks, such as those we've discussed, with rigor and insight. By learning to translate data into actionable strategies, you'll be well-equipped to make informed decisions and drive business success. For more information on courses, visit the curriculum page.

Cost analysis is an indispensable tool for effective financial management and strategic decision-making in business. With advanced courses like "Analytics for Financial Decisions and Market Insights" and "Enhancing Stakeholder Relationships in the Age of Analytics," Seattle University’s Online MSBA program equips you with the skills needed to excel in this critical area.

The rigor of the curriculum, combined with hands-on, real-world challenges, ensures that graduates are well-prepared to analyze business operations, new product offerings and investments to make data-driven decisions that promote business success.

Ready to advance your career in business analytics? Schedule a call with an admissions outreach advisor to learn how Seattle University's Online MSBA program can support your professional growth.