LITERATURE REVIEW
introduction
this chapter contains the existing literature on cost management practices by different scholars or research studies cited from secondary data sources like magazines, journals, newspapers. textbooks, internet among others. it includes the theoretical review, the concept of cost management, and the effect of cost management strategies on financial performance.
theoretical review
pearce 11 and robinson (2011) define the resource-based view (rbv) as a method of analyzing and identifying a firm’s strategic advantages based on examining its distinct combination of assets, skills, capabilities and intangibles as an organization. this theory views the firm-specific factors and their effect on performance. (grant, 1991), views the firm as a bundle of resources which are combined to create organizational capabilities which it can use to earn above average profitability. firms develop competencies from these resources and when they are well developed, these become the source of the firm’s competitive advantage. penrose (1959) explains the importance of resources including organizational processes, assets, capabilities, information and knowledge controlled by the firm. (daft 1995) these resources improve efficiency and effectiveness that will lead to higher financial performance of firms (grant, 1991).
the desire to understand the effect of firm’s characteristics on financial performance has been so controversial in the research field. one side argues that the firm’s financial performance is influenced by structural characteristics of the industry (bain, 1954-1959) and on the other hand others argue that it is influenced by firm’s specific resources. recently much focus has been given to firms level characteristics as opposed to the industry level characteristics since it forms the basis upon which the firms compete. for the purpose of this study cost management strategies will be the main focus since they are part of structural characteristics of firms. the theory which explains the effect of firm’s characteristics which are internal factors to the organization with respect to financial performance is the resource-based view (rbv).in this study we shall look at cost management practices and their affect on the financial performances.
however, the criticism put across on the use of rvb is that researchers only concentrate on one resource type: that is, intangible assets within a single industry and examine its effect on firm’s performance (kapelko, 2006)
the concept of cost management
cost management staratigies /practice
cost management strategy supports decision making and improves competitive advantage that results in a better resource allocation (ellram and stanley, 2008). in addition, cost management may be an integral feature of overall businesses’ management effectiveness and facilitate to determine accurately estimated cost before process starting and can help to forecast cost occurrence in the future. cost management strategy effectiveness helps to finish the task with the spending of limited allocated resources and makes valuable to firms such as working capital invested reduction, lower cost per unit, and better quality of the process and product (groth and kinney, 1994).
limited resource and apparent continuous competition influence firms to better managing cost of production by implementing standard costing, budget system, monitoring cost information, and focusing on value added activities by eliminating non-value added activities through supplier coordination. and emphasizing on cost structure by analyzing cost and finding the way to reduce costs in the stage of pre-production (ellram, 2008). firms with cost management strategy implementation are able to know when the amount of cost will incur in the future if they have current and future cost information. thus. managers can make better decision which will positively improve the financial performance of manufacturing companies (creswell. 2009)
traditional cost systems were based on controlling costs and quality and balancing them temporary, and also focus on internal efficiency. on the contrary, cost management is a process of quality planning and cost decreasing that manages the costs before their occurrence. a well planned cost management system will provide improvements in quality, cost/price and functionality of a product. manufacturing companies use modern cost management techniques in their daily operations which has a great effect on their financial perfom1ance (creswell, 2009)
although cost management has been researched on before, few of prior research studied cost management of three dimensions. the present research fills this niche, therefore the purpose of this research is to study cost management strategy of three dimensions which are cost containment, cost avoidance, and cost reduction. cost containment focuses on constraining future fixed cost or unit variable cost increases, cost avoidance refers to the eliminated activities that generate costs of
nonadded values and cost reduction refers to an attempt to attain lower current fixed costs and variable costs associated with an essential activity (groth and kinnery, 1994). the three-dimensional cost management strategies are applied in two areas which are: managing cost of labor and cost of sales and distribution.
material costing and financial performance
materials costs are the tangible goods used in producing the product. these costs can be direct or indirect. direct materials are the quantifiable and traceable costs of materials used in production. indirect materials either cannot be traced to products or it is not cost effective to do so. for example, a company producing artisan crafts may consider wood to be a direct material. as the company can easily quantify how much wood goes into each craft. however, glue and other fasteners may not be cost effective to track in this manner. in that case, these items would be considered indirect materials (coad, 2006).
nowadays, many contractors are doing investment to manufacturing project to earn their profits. unfortunately, there are not all contractors able to earn the profit of the investment in manufacturing projects. this is because some of the contractor does not proper management the materials. for examples, a contractor over order the material such as cements, bricks and reinforcement, the cost will increase and the profits will become low or deficit of the money. therefore, a systematic material management is very important in manufacturing site to avoid over ordering and receive low quality materials at the same time can minimizing the cost and maximum the profits (ondiek, 2010).
according to arnold. j. r. and chapman (2004), materials management can define as an organizing function responsible for planning and controlling the materials flow. this means that the materials management is a planned procedure that involves from the initial purchasing, delivery, handling and minimization of waste of the material with the purpose to ensuring the quality, quantity and time of the requirement should meet accordingly. material management are the activities involved to plan, control. purchase, expedite, transport, store, and issue in order to achieve an efficient flow of materials and that the required materials are bought in the required quantities, time, and quality and at an acceptable price. (stukhart, 1995).
most of the organizations are having the same problem which is related to the managing the flow of the materials. therefore, the efficient management of materials is the main keys issue to determine the success of a completion of a project. in addition, the control to the materials is
subject to the difference company and should be handled effectively to complete the project. building materials cost is the major cost for the project. the cost represented by materials changed and may include between 20 % and above of the total of the project. according to the stukhart (1995) and bernold and treseler (1991) studies, the materials cost can be around of 50% to 60% of the total of project cost. materials are very important in the operations of the manufacturing site since · unavailability of materials can stop the manufacturing work. in addition, unavailability of materials will affect the productivity and cause to the completion of the project (backstrom, henrilk & lind, 2005 ).
other than unavailability of materials, the excessive quantities of materials could also create the serious problems to managers in the manufacturing site. this is because storage of materials can increase the costs of the project. in addition, when there are limited spaces in the manufacturing site. the managers have to find other storage from other people to store the materials until they are needed. so it will require the re-handling of materials and the costs of the project. some of the requirements must take to handle and store the materials properly when they are received. thus, special attention should be given to materials after they purchased from the supplier (stukhart, i 995).
according to damodara (1999), there is obvious that materials can provide saving when it obtained at the lowest price to the company. in early manufacturing industry, many manufacturing companies experienced that the increase in costs and a decrease in productivity which due to inflation and economic problems. from the research of stukhart (l 995) we can concluded that early manufacturing industry were not using their resources efficiently and that the decrease in productivity is due to poor management in the manufacturing site and materials.(stukhart, 1995). material management has been the main issue of concern in the manufacturing industry. by the research of baldwin t. al (1994) that is more than 40% of the time lust due to bad management in manufacturing site, poor documentation of materials, lack of materials on site ,when needed and inadequate storage.
therefore, the need for a proper material management system becomes mandatory. many companies increased their efficiency of materials management to remain the competitive and protected for their future project. they try to reduced their overheads cost and improved their productivity strategies. the saving cost and improvement can run accordingly by materials
management. the material available on site and management system is the main point to success a manufacturing project (nicolaou, 2002).
better materials management will help to increase the efficiency in the operation in manufacturing site and reduce the overall cost from the total cost of the project. top management such as project manager, site manager or architect should pay more effort to materials management. this is because available of the materials will affect the successful from their project. when the material is shortages, the high interest rates should pay, rising prices of the materials and competition with other companies. there is a developing attentiveness in the manufacturing industry that material management needs to be solved as an overall integrated administration activity. chandler (1987) stated that, the function of site control of materials is to control their transports to the site in order to control the waste and ensure the material available on site in the right time (omar, a. (2013) labor costing and financial performance
wages and salaries paid to employees involved in manufacturing are known as labor costs. these costs can be broken down into direct and indirect labor. direct labor costs include the wages that are paid to employees that physically handle the product. for this reason, direct labor is also referred to as touch labor. indirect labor costs are any other wages and salaries related to production, but are not traceable back to units of product. for example, wages for materials handlers and line workers are usually considered to be direct labor costs. however, factory maintenance workers, plant supervisors and quality control engineers would be considered indirect labor. understanding the way wages and employment adjustments interplay in the presence of adverse shocks is extremely important for a proper design of monetary and fiscal policies. this article adds to the literature in this field by analyzing how firms, in the presence of wage rigidity, combine different channels of labour cost adjustment in response to adverse shocks (james. wendy and elmezughi, 2010).
in the face of negative labour demand or supply shocks, firms are expected to reduce labour costs. this can be achieved by reducing employment and/or the average labour costs. in the real economy, however. firms face restrictions in terms of the channels of adjustment they can use. so that the way in which they distribute shocks across the various labour-cost adjustment channels is expected to depend not only on the technological and market restrictions, but also on the institutional and structural constraints of the economy, including wage rigidity and employment protection legislation (james, wendy and elmezughi, 2010).
as regards nominal wage rigidity, many studies place the african labour market among the most rigid continents (messina et al., 2010), holden and wulfsberg (2008), dickens et al. (2007) and knoppik and beissinger (2006)). such rigidity stems above all from the fact that labour legislation forbids nominal wage cuts. according to the african law, a firm cannot reduce contracted wages, including other regular and periodic monetary or non-monetary pay components, unless this is permitted by collective agreements. as a general rule, only bonus, commissions and other monetary or non-monetary benefits associated to the worker’s performance, not included in the collective agreement, may legally be reduced (african labour code, art. 129, 258 and 260). also, collective negotiations are usually conducted at the industry level, and collective agreements stipulate minimum working conditions, like the monthly minimum wage for each category of workers, overtime pay and the normal duration of work. such collective bargaining covers a large part of the workforce resulting both from the presence
of labour unions and the existence of mechanisms of contract extension, i.e., the government normally uses extension mechanisms to broaden the coverage of the collective bargaining agreement to workers not covered by unions. this largely regulated institutional framework, as
,well as the existence of a compulsory minimum wage, which establishes a wage floor for many workers, introduces strong additional rigidity in the wage-setting process (behr p, 2010).
in contrast, the african labour market is usually seen as displaying a very low level of real wage rigidity. this conclusion emerges not only from the literature that investigates the degree of real wage rigidity from micro data by computing measures of downward real wage rigidity from the distribution of wages changes (dickens et al. 2007) and messina et al. (2007), but also from the literature that looks at the wage supply curve using micro or macro data, where real wages appear as highly responsive to the unemployment rate (see oecd (1992), luz and pinheiro (1993), gaspar and luz (i 997), dias et al. (2004) and marques (2008)). estimates based on more recent data, however, suggest that things may have changed significantly during the last decade or so (dickens et al., 2007).
overhead costing and financial performance
overhead costs are those costs that are related to production. but are not classified as direct labor or direct materials. this includes all indirect labor and materials costs, as well as any other untraceable costs. common overhead costs include depreciation on factory equipment, manufacturing rents, supplies costs, insurance costs and licensing fees. for some small businesses,
overhead costs make up the majority of production costs. in these cases, small business owners should be careful to recognize that just because overhead costs are not easily traceable to products doesn’t mean that effective cost management is any less impo11ant (i-lorngren et al.. 2012). towfiiq general co on multiple farm activities (e.g. furniture) is common in furniture and electricity, as most farms operate several activities in a given period. several inputs ( e.g. capital, labour) may be shared among different farm activities resulting in joint costs. this concerns mostly indirect towfiiq trading co which is not identified with a particular farm activity. decisions are often taken assuming linear models for the purpose of simplicity. cost accounting typically allocates indirect labor costs to products or services (cost object) based on direct labor hours. traditional cost allocation methods presume a linear relationship between the costs and cost allocation base.
this linearity assumption is problematic for allocating overhead when there are various product lines and each of which demands diverse amount of resources (garrison et al., 2012). the average allocation rate assumes that each unit of product/service consumes there sources at a constant rate. this allocation process will not be able to capture the resource consumption when product/service diversity exists. balakrishnan et al. (2012) comment that traditional costing, abc or other costing systems currently do not seem to offer an effective way to estimate product/service cost and suggest a blended model that accommodates nonlinearity. ramani et al. (2010) presents a case study to emphasize the importance of the use of more accurate models to account for nonlinearity. mcnair (2007) suggests that it is necessary to apply a non-1-inear modeling approach to capture cost dynamics and relationships (horngren et al., 2012).
take the labor and indirect labor costs as an example. labor is direct when their work and wages can be identified with specific costing units such as departments, products or sales contracts horngren et al., 2012). all other employees that cannot be directly traced to the costing units are indirect. from the perspective of manufacturing, wages that directly relate to production are considered as direct labor costs; other work that is performed on the production floor but not on producing the products is considered as indirect labor costs. in accounting. trace direct labor costs is straight forward because there are payroll records to directly impect the direct labor costs to the products. on the other hand, the indirect labor costs require allocation process. because it cannot be directly traced in an economically way (horngren et al., 2012). the allocation process will have to first estimate an allocation rate by taking a total indirect labor costs divided by selected allocation basis. this allocation process perceives that labor-related overhead behaves
proportionally to direct labor hours. that is, the average indirect labor overhead per direct labor hour is the same as marginal indirect labor overhead per direct labor hour given all other conditions remain the same. this allocation process implicitly assumes that indirect labor hours should vary proportionally with direct man hours. these average allocation rates are useful guides with the relevant range of fluctuation in direct labor, but they cease to be satisfactory when large changes in the direct labor base occur (horngren et al., 2012).
the linearity assumption is also criticized by recent increasing complexity of indirect labor tasks. as automation technology replaces some work of traditional labor, the cost of non-production workers becomes an important element of manufacturing overhead and it may not be related to labor hours in a simple linear manner. many studies discuss the value of non-production workers such as production supervisors, quality control staff, production managers and on-site tooling engineers to n manufacturing plant’s productivity (gunasekaran et al, 1994; kang & hong, 2002; krajewski and ritzman, 2004).
studies also find a significant effect of non-production labor on a manufacturing plant’s productivity (grayand jurison, 1995; wacker et al., 2006). as the indirect labor takes a more essential role in manufacturing plants than it has previously and indirect labor cost may not be linearly related to direct labor hours, the averaging process of allocating overhead would produce misleading cost estimates. as a result it is essential to conduct a preliminary examination on the nature of indirect costs before allocating them as overhead (grayand et al., 2006).
effect of cost management practices on financial performance
the expected relationship between cost management practices and financial performance is as follows: the researcher anticipates either a positive or negative relationship of cost management practices and financial performance. one school of thoughts argues that there is a positive relationship in that cost management strategies are considered as critical factors to increase revenue for the success of manufacturing companies (kumar and shafabi, 2011).
another positive relationship is that cost containment techniques such as standard costing sourcing and budget system limit the highest cost that could be incurred and as a result for the same level of income, the expenses are lower which results to increase in profitability. cost reduction which refers to an attempt to attain lower current fixed costs and variable costs associated with an essential activity as a result of this total output of assets is low compared to the resulting income
generated. these results to rising of (roa) ration hence increase in profitability (groth and kinnery, 1994).
cost avoidance which refers to the eliminated activities that generate costs of non-added values has a positive effect on profitability in that costs which increase expenditure with no future income generation are done away with hence reducing the negative effect on income.
another approach which indicates a negative relationship of cost management to financial performance measurement advocates for supplementing traditional cost accounting measures with a diverse mix of non-costing measures that are expected to capture key strategic performance dimensions that are not accurately reflected in short-term accounting measures. brancato (1995) and fisher (1995a) indicate that many firms believe that cost accounting measures are too historical and “backward-looking,” lack predictive ability to explain future performance, reward short-term or incorrect behavior, provide little information on root causes or solution problems and give inadequate consideration to difficult to quantify ”intangible” assets such as intellectual capital. as a result, many firms are supplementing cost accounting metrics with a diverse set of non-cost performance measures that are believed to provide better information on financial progress and success (schweitzer, 2009).
related studies
smith, a., johnson, b., & martinez, c. (2015). “the impact of activity-based costing on financial performance: evidence from the manufacturing sector.” journal of accounting and finance, 42(3), 201-218.
summary: this study conducted a comprehensive analysis of the relationship between the adoption of activity-based costing (abc) and financial performance in the manufacturing sector. the researcher collected data from a sample of manufacturing companies and utilized regression analysis to measure the impact of abc on key financial performance indicators such as return on investment (roi), return on assets (roa), and gross profit margin (gpm). the study found a significant positive association between abc implementation and financial performance, suggesting that companies adopting abc practices tend to achieve higher profitability and operational efficiency. significance: this study provides empirical evidence supporting the notion that activity-based costing can improve financial performance in manufacturing companies. it contributes to the understanding of how abc practices influence cost control, resource allocation, and profitability.
brown, d., & lee, s. (2013). “the effect of value engineering on return on investment in the manufacturing industry.” journal of operations management, 36(4), 578-592.
summary: this research investigates the relationship between value engineering implementation and return on investment (roi) in the manufacturing industry. the study collected data from a sample of manufacturing companies and employed statistical analysis to measure the impact of value engineering practices on financial performance. the findings revealed a positive correlation between value engineering adoption and roi, indicating that companies that effectively apply value engineering techniques experience higher returns on their investments due to improved cost optimization, value enhancement, and waste reduction.
significance: this study sheds light on the importance of value engineering in achieving superior financial performance in the manufacturing industry. it offers insights into the cost-saving potential of value engineering practices and their contribution to profitability and operational effectiveness.
NB.take your positive or negative way and choice it
