Cost Cutting Definition - Investopedia

Cost cutting refers to measures implemented by a company to reduce its expenses and improve profitability. Cost cutting measures are typically implemented ... Business CorporateFinance WhatIsCostCutting? Costcuttingreferstomeasuresimplementedbyacompanytoreduceitsexpensesandimproveprofitability.Costcuttingmeasuresaretypicallyimplementedduringtimesoffinancialdistressforacompanyorduringeconomicdownturns.Theycanalsobeenactedifacompany'smanagementexpectsprofitabilityissuesinthefuture,wherecostcuttingcanthenbecomepartofthebusinessstrategy. KeyTakeaways Costcuttingisameasuretakenbyacompanytoreduceitsexpensesandimproveprofitability.Whenacompanyisinfinancialdistressorthereisaneconomicdownturniswhencompaniesaremostlikelytoenactcostcuttingmeasures.Costcuttingmeasurescanincludelayingoffemployees,closingfacilities,downsizingoffices,andstreamliningthesupplychain.Whenembarkingoncostcuttingit'simportanttohaveacostcuttingstrategythatclassifiescostsasbadcosts,goodcosts,andbestcosts.Aspartofacostcuttingstrategy,it'simportantforacompanynottoovercutcosts,leavingitunpreparedforincreaseddemandorinapositionwhereitmayincurmorecosts. UnderstandingCostCutting Shareholderswhoseekmaximummonetaryreturnsontheirinvestmentsinacompanyexpectthatmanagementwillmaintaingrowthinprofits.Whenthebusinesscycleisonanupswing,companiesaregenerallyabletogenerateprofitgrowth.However,onadownswing,profitsmayfallandiftheystaydownforprolongedperiods,managementwouldfeelthepressurefromshareholderstocutcostsinanefforttopropupthebottomline. Costcuttingmeasuresmayincludelayingoffemployees,reducingemployeepay,closingfacilities,streamliningthesupplychain, downsizingtoasmalleroffice,ormovingtoalessexpensivebuildingorarea,reducingoreliminatingoutsideprofessionalservices,suchasadvertisingagenciesandcontractors,etc. Implementingnewtechnologycanalsobeseenasacostcuttingmethod.Forexample,anewmachinemayreplaceacertainnumberofemployees,cuttinglaborcosts,wherethecostofthemachineismadeupafteracertainperiodoftimeofnotincurringlaborcosts. CostCuttingStrategy Whenembarkingoncostcutting,it'simportanttoimplementastrategybeforearbitrarilycuttingcosts.Somecostsarenecessary,soit'simportanttoclassifycostsintogoodcosts,badcosts,andbestcosts. Goodcostsfocusonthecompany'sgrowthandarealignedwiththecompany'scustomersandhowtomeettheneedsofthosecustomers.Badcostsarethosethatdonotmatchupwiththecompany'sgrowthstrategy,andwasteresources.Whenbadcostsarecut,theycanfreeupresourcesthatcanbeusedinamoreproductivecapacity.Bestcostsarethecostsassociatedwithwhatmakesacompanyunique,howitdifferentiatesitselffromthecompetition,andhowitprovidestruevaluetoitscustomers. Onceacompanyisabletoallocateitscostintooneoftheaboveclassifications,itwillmakeiteasiertofocusoncuttingbadcostsandmaximizingonbestcosts. It'salsoimportanttonotethatcostcuttingdoesn'tnecessarilymeancompletelycuttingacost.Itcanalsorefertooptimizationandefficiency.Optimizingproductivityactuallyreducescosts,soit'simportanttomeasureproductivity.Todaythereareappsthatallowcompaniestomonitortheproductivityofemployeesaswellastimespentondifferentworkandprojects. RisksofTooMuchCostCutting Becausesalariesandwagesaresuchalargeexpense,manycompanieslooktolayoffs firstasacostcuttingmeasurewhentimesarelean.However,therearemanyrealorpotentialcostsassociatedwithfiringpeople,includingseverancepay,unemploymentbenefits,rehiringcosts,wrongfulterminationlawsuits,loweringofmorale, andtheriskof overworkingremainingemployees. Additionally,ifthebusinessturnsaroundfasterthanmanagementhadexpected,thecompanycouldfinditselfwithashortageoflabor,placingthecompanyatacompetitivedisadvantageinanimprovingbusinessenvironment.Also,ifafactorywasclosedinarecentroundofcostcutting,thecompanymaynothavesufficientproductioncapacitytorespondtoasuddenincreaseinorders.Thisallfactorsintoensuringacompanyhasasoundandadaptablecostcuttingstrategy. RelatedTerms BusinessNetRetention Businessnetretentionisthenumberofpoliciesthatremainafterdeductingcanceled,lapsed,orcededpoliciesfromthetotalunderwritten. more WhatIsLeanSixSigma? LeanSixSigmaisateam-focusedmanagerialapproachthatseekstoimproveperformancebyeliminatingwasteanddefects. more WhatIsAttritioninBusiness? Attritionisthegradualbutdeliberatereductioninstaffasemployeesretireorresignandarenotreplaced. more SupplyChainManagement(SCM):HowItWorksandWhyItIsImportant Supplychainmanagement(SCM)isthemanagementoftheflowofgoodsandservicesaswellasoverseeingtheprocessesofconvertingoriginalmaterialsintofinalproducts. more ManagerialAccountingMeaning,Pillars,andTypes Managerialaccountingisthepracticeofanalyzingandcommunicatingfinancialdatatomanagers,whousetheinformationtomakebusinessdecisions. more CostAccounting:DefinitionandTypesWithExamples Costaccountingisaformofmanagerialaccountingthataimstocaptureacompany'stotalcostofproductionbyassessingitsvariableandfixedcosts. more PartnerLinks RelatedArticles CompanyNews Halliburton(HAL)TradingHigherAfterMixedQuarter CompanyProfiles 5CharacteristicsofRecession-ResistantCompanies AlternativeInvestments TheFourRsofInvestinginRetail HowtoStartaBusiness BusinessDevelopment:TheBasics CorporateFinance CapExvs.OpEx:What’stheDifference? 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