Cost Modeling: The Difference Between Expenses and Costs

Strategic cost management has become a hot topic given the continued economic concerns and pressures on corporate earnings. By now, most companies have done the basics to help drive expenses out of their businesses such as reducing staff, outsourcing, rationalizing capital projects and improving procurement. However, there are significant differences to be understood between expense management and strategic cost management. First and foremost, we must understand the difference between how we define expenses versus costs.

Understanding Expenses

Expenses are incurred, used as a measure for accounting purposes, which measure the financial performance of an organization. Accounting for expense is standardized by Generally Accepted Accounting Principles (GAAP) to provide shareholders, regulators, and management a standard and comparable view of financial information across diverse industries. Technically, an expense is a specific accounting event related to the outflow of cash reducing corporate equity. Expense simply record the event and used to understand ‘what happened’ from an accounting perspective.

Understanding Costs

Costs are derived, used as a measure for economic purposes, which measure the economic performance across multiple dimensions of business, (organization, product, customer, etc.). A cost is a derived value of money consumed to produce a current or future outcome; hence, costs provide management a decision supporting view to improve business economics. Costs are expressed as a value measured in relationship to a causal volume of consumption.

The benefit of leveraging strategic cost management over traditional expense reductions is the ability to measure efficiency and effectiveness in financial terms. Companies are flying blind when making decisions from the expense view without a comprehensive understanding of the business economics behind the incurred expenses. Only through a well designed enterprise cost modeling effort can companies confidently make decisions regarding product pricing, market effectiveness, and process efficiency to optimize corporate profitability.