Cost Breakdown Analysis

Claudia Westenhoff

Does your company need transformation? A cost breakdown analysis is a breakdown of all expenses incurred in connection with a product or service. In this blog post, we will explain how such an analysis can work with the help of an example!

Why is the analysis so important?

The cost breakdown analysis breaks down the expenses of a specific product or service into their various components, the expense drivers. The goal is to understand the drivers and to be able to influence them in order to be able to keep expenses at the desired level in the long term. Establishing cost breakdowns as a strategic tool can save companies a lot of money. By providing a detailed breakdown of costs, it enables the identification of new potentials in addition to a high level of transparency. Drivers and outliers can be identified and avoided immediately. Freed-up liquidity not only serves as a buffer, of course, but can be reinvested - therein lies the greatest potential of Cost Breakdown Analysis!

Important: Distinguish in the cost management in principle between expenditure and costs! Expenses include the value of all goods and services consumed by a company. An example would be the salaries of the employees or the invoice of the suppliers. Costs, on the other hand, are referred to as "consumption of goods for operational purposes". This means that the consumption of goods must be related to the purpose of the company. Consequently, not every expense represents a cost, but conversely, costs always count as expenses.

Not every cost breakdown always works the same way, because the respective expense structure determines the analysis significantly. However, there is a basic procedure, which we would like to present to you broken down now. You will find a more detailed description in the following PDF resource - completely free of charge from us for you!

The Cost Breakdown Analysis Basic Procedure:

Step 1: Split expenses

Divide all expenses incurred (e.g. in a year or quarter) into the main expense types. For manufacturing companies, these are usually expenses for materials, labor, manufacturing, logistics, overhead, and other expenses. A software manufacturer would perhaps add servers and licenses.
In any case, a good form of presentation is the EBITDA bridge (also called waterfall chart). It shows at a glance which driver is a real revenue hog.

Important: Try not to create more than 6 to 8 main effort groups. If there is a collective item (e.g. other expenses) it should not exceed one fifth of the total expenses.

Step 2: Showing the development over time

The development of expenses over time is often the most important step, because it shows you whether - in relation to sales - expenses are increasing disproportionately. And this is where the hare is in the poke, because you should always keep a close eye on the relation to income.
A good form of presentation brings all components together. Popular are also divisions into fixed and variable expenses or Pareto representations. But no matter which form of presentation you prefer during your analysis, try to interpret and explain the analysis. Because the increase of an effort driver (here e.g. the cost of materials) must always be explainable!

Step 3: Competitor comparison

Of course, it is also important to keep an eye on the competition. Especially in the case of expenses, the availability of data via the Bundesanzeiger (Federal Gazette) and the like is usually quite revealing. Try to create as representative a group of competitors as possible and a comparison for each of your cost drivers (in absolute values and in relation to sales or EBITDA).

Step 4: Derive potential measures

With the knowledge gained, ideas for measures usually arise relatively quickly. Try to roughly describe the measure ideas and assign a rough effect to them. If you have noticed, for example, that the cost of materials has increased because the outdated machinery has a high reject rate, you could roughly determine what cost of materials would be possible with new machinery and initiate a small investment calculation.

Frequent measures
There is a wealth of measures that can be developed as part of a cost breakdown analysis. But there are real evergreens that come up again and again:

  • Overhead reduction
  • Material cost reduction
  • Personnel cost reduction

For more information on these measures and more on cost breakdown analysis (Cost breakdwon Analysis), see the following resource in condensed form. Download your guide as a PDF now for free!

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