Financial Analysis and Cost Audits: Identifying Cost Inefficiencies

Identifying cost inefficiencies is crucial for cost reduction, with financial analysis and cost audits serving as key tools. Cost audits also play a vital role in ensuring the sustainability of these optimization measures.

Financial analysis and cost audits are indispensable tools in cost management, essential for evaluating unnecessary expenditures and ensuring the sustainability of cost optimization results.

In this article, we introduce common strategies for financial analysis and cost audits amid a company’s cost reduction efforts.

Financial analysis for evaluating savable costs

Financial analysis involves collecting, organizing, and analyzing a company’s financial data to provide insights into cost structure, profitability, and operational efficiency. This helps management make informed decisions, adjust cost strategies, and optimize resource allocation.

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By comparing financial data over different periods, financial analysis can reveal trends and reasons for cost changes, identifying potential cost-saving opportunities. For example, if an expense is consistently rising without corresponding revenue growth, management might consider reducing that expense or finding more economical alternatives. Additionally, businesses can leverage financial analysis to renegotiate contracts with parties responsible for recurring, substantial fixed costs.  In this context, financial analysis often serves as the initial step in cost optimization efforts.

Furthermore, after implementing cost optimization measures, financial analysis evaluates their effectiveness by comparing data before and after the changes, assessing the extent of cost savings and their impact on profitability.

What to analyze?

In accounting, costs are divided into direct and indirect costs. Direct costs include the cost of principal activities, other activities, and taxes and surcharges on operations. Indirect costs encompass selling and distribution expenses, general and administrative expenses, financial expenses, and impairment of assets. For cost optimization purposes, financial analysis should focus on expenses that exceed industry averages or historical data. Initially, accounting analysis is necessary to identify the top costs for the company or industry and those that have significantly increased.

To be more specific, the below issues need special attention:

• Cost structure analysis: Focus on the proportion of various costs, and identify high-cost areas and cost growth trends, particularly the distribution of variable and fixed costs.
• Profit and efficiency analysis: Evaluate key indicators such as profit margins and asset turnover rates to understand the company’s profitability and operational efficiency.
• Cash flow analysis: Monitor the stability and adequacy of cash flow to ensure the company has sufficient funds to support daily operations and address potential risks.

During the process, companies are suggested to make multidimensional comparative analysis, comparing not only historical data but also industry benchmarks and competitors to identify gaps and improvement opportunities. Besides, sensitivity analysis is also recommended—conducting sensitivity tests on key cost factors to predict cost changes under different scenarios provides a basis for decision-making.

Regular cost audits for continuous and sustainable improvement

Cost auditing involves examining a company’s cost data to ensure its authenticity, accuracy, and completeness, preventing tampering or misreporting and ensuring the reliability of cost information.

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Audits can uncover issues such as irregular cost accounting or unreasonable cost allocation, which, if left unaddressed, can lead to inflated costs or waste, impacting profitability. Auditors provide recommendations for improvement, including enhancing cost accounting methods and optimizing cost control processes, which helps improve the overall cost management system.

Through cost auditing, a company gains a clearer understanding of its cost structure and levels, enabling the development of targeted cost optimization strategies. For instance, an audit might reveal cost waste, prompting measures to reduce unnecessary expenses or identify irregular cost accounting, leading to improvements in the cost accounting system.

How to conduct cost audits

Conducting a cost audit involves several key steps to ensure a thorough examination of a company’s cost management activities. The first step is to define specific audit goals and scope based on the company’s situation and cost management needs. Clear objectives are crucial as they help focus audit efforts on the critical areas requiring attention.

Next, auditors employ professional methods and tools to conduct a comprehensive audit. During the audit process, auditors collect evidence, analyze financial data, and evaluate the execution of cost management systems. Sufficient evidence is gathered through reviewing financial records, interviewing key personnel, and observing cost management practices. After completing the audit procedures, auditors summarize and analyze the results to form a comprehensive audit report.

The key focus areas for cost audit are:

• The soundness of cost management systems: Check whether the company has established and effectively implemented comprehensive systems.
• Accuracy of cost accounting: Verify the authenticity and accuracy of cost accounting data to prevent false or omitted costs.
• Effectiveness of cost control: Evaluate the impact of cost control measures and analyze any problems or deficiencies in the process.

Tax saving as an example

While financial analysis focuses on evaluating a company’s overall financial status and performance, cost auditing emphasizes the authenticity and compliance of cost data. Both processes complement each other, promoting continuous improvement and optimization of cost management.

For example, through financial analysis, if a company identifies opportunities for tax savings, it may develop a series of targeted measures, such as:

• Change corporate structure: Subsidiaries and branches have different tax implications. Companies may consider changing organizational structure to achieve tax savings.
• Leverage tax incentives: China has implemented various special tax incentives to encourage specific industries and regional economic development. Companies may endeavor to exhaust all available tax breaks to maximize savings.
• Reasonable allocation and expense recognition: Companies can save taxes by appropriately allocating and recognizing costs. Strategies include minimizing expense payments and maximizing cost allocation to reduce taxable income.
• Choose the right tax filing approach: Some taxes in China allow companies to select filing methods based on their operational capacity and specific needs.

Subsequently, regular cost audits will assess and evaluate the effectiveness of the tax-saving measures, contributing to a sustainable cost optimization ecosystem.

Adopting automation and digitalization for better analysis and control

With the development of digitalization and automation technologies, companies can use ERP, MES, and other information systems to achieve real-time collection, analysis, and monitoring of cost data, improving the efficiency and accuracy of financial analysis and cost management. Additionally, advanced technologies such as big data analysis and artificial intelligence (AI) enable companies to more accurately predict cost trends and develop scientific cost control strategies. Companies can consider the following digitalization/automation methods:

• Establishing a digital cost management system: Integrate ERP, MES, and other system resources to build a comprehensive cost data collection and analysis platform, achieving real-time sharing and in-depth mining of cost data.
• Promoting intelligent cost control: Use AI algorithms to intelligently analyze cost data, identify cost wastage points and optimization opportunities, and propose intelligent cost control solutions.
• Enhancing cost data monitoring and early warning: Establish cost data monitoring mechanisms to monitor cost changes in real-time and initiate early warning procedures immediately upon detecting anomalies, ensuring the effective implementation of cost control measures.

Summary

In conclusion, financial analysis and cost audits are essential tools for effective cost optimization. By thoroughly analyzing financial statements, conducting regular cost audits, and utilizing digital and automation technologies, companies can more accurately identify unnecessary expenditures in operations, continuously refine cost management strategies, and achieve cost optimization and maximization of benefits.

Also Read:

• Renegotiating Long-Term Commercial Contracts for Greater Cost Savings
• Reducing Labor Costs in China with a Sustainable Workforce Structure

(This article is an excerpt from the latest issue of China Briefing Magazine, “Cost Reduction Strategies in China“.)

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