Overhead Cost Management

Gaining Control of Overheads...

How Cost Structures have changed:

Cost Category	1960	1986	1996	2004
Overheads	15%	30%	35%	48%
Direct Labor	25%	12%	10%	10%
Direct Materials	60%	58%	55%	42%

Currently between 40% to 50% of companies' costs are Overhead Cost related, costs other than purchased materials. Overhead Cost Management has become critical and if managed effectively can greatly contribute to increased organizational profitability. Understanding the sensitivity and dynamics of cost in terms what is controllable (variable) and what is fixed is a key element to Business Success…

...but where has management been spending their time?

• Work Study Departments have been actively measuring and controlling Direct Labor - resulting in direct labor costs reducing as percentage of overall costs.
• Purchasing Departments have been effective in sourcing direct materials from lower cost suppliers...
• But..very little effort has gone into Controlling and Managing Overhead Costs

So, what is the Solution? How do organizations Gain better Control of their Overheads?

A definitive start is understanding the three key areas of overhead management:

Cost Accountability is defined as assigning responsibility to individuals within the organization responsible for the expenditures incurred over which they have control. Cost Center Accounting provides the ability to assign Cost Centers to departments and /or Managers responsible for certain areas of the business as well as functional areas within your organization. Cost Centers can be created for functional areas such as Marketing, Purchasing, Human Resources, Finance, Facilities, Information Systems, Administrative Support, Legal, Shipping/Receiving, or even Quality. The owners of the cost centers would be responsible for basing their cost planning on good performance standards. Measuring actual performance by comparing actual cost against a dynamic plan as opposed to a static budget is a fundamental key to improving performance

Accurate Cost Centre Activity Rates are the result of cost centre managers understanding the cost drivers and their sensitivity to cost. Variable and Fixed components of cost are determined by making use of cost engineering techniques. Measuring the actual cost against dynamic standards then becomes not only meaningful, but also a tool for quality control of the standards. The result is a continuous improvement process of cost centre activity rates and cost savings through productivity improvements.

Gaining a deep understanding of your Cost Base provides the base data for continuous improvement campaigns in many areas:

• Capital feasibility studies on new technology for energy savings in energy intensive processes
• Immediately able to evaluate impact on profitability of any product mix changes
• Evaluation of in-house production vs. external/3rd party processing
• Evaluation of capital feasibility studies like introducing new technology or analyzing alternative production methods

• Cost Center owners set a budget for the cost centers for which they have responsibility
• Budgets are split between fixed and variable costs
• Cost Drivers (Activities) can be identified for individual Cost Centers and costs can be planned activity dependently.
• Activity Dependent costs can be split between fixed and variable portion.
• Variable portion of budget “flexes” with activity output
• Cost Centers can be aligned to functional areas of the organization
• Cost and Overhead Accounting provides dynamic capabilities for planning both direct(variable) as well as indirect (fixed) costs
• Cost and Overhead Accounting Activity rates are automatically calculated with the rate split between fixed and variable portion
• Cost can be allocated between cost centers using allocation methods
• Costs can be assessed/distributed to other types of cost objects – for example production orders.

Click here to download a copy of the Overhead Cost Management flyer