Definition: Cost savings is a set of actions or policies that reduce the historical or expected cost of a given transaction. They are measures implemented to shrink the amount of money being paid for a certain good or service.
What Does Cost Savings Mean?
Cost saving can be defined as an action or a systematic strategy. Companies with solid financial policies have different ways to ensure any purchase or investment being made goes through a cost savings method. From an organizational or business perspective, this strategy is mostly implemented at the purchase department. Since this is the functional area that handles all purchases being made by the company, the strategy can be more effectively implemented there.
One of the ways this can be done is submitting each purchase requirement to a systematic process of bidding, where suppliers are asked to present their proposals. At least three suppliers will be normally required to say that a cost-savings approach was taken. For businesses, cost savings is essential when it comes to raw materials and other crucial elements within the cost structure. Companies normally target the top items that produce the highest cost and look for strategies to reduce them.
Example
Santa Teresa Co. is a company that produces alcoholic beverages in Mexico. The main two products sold by the company are rum and whisky. Each of them required very specific chemicals and raw materials that account for 60% of the total cost per unit. Currently, the Board of Directors is looking for ways to reduce the cost of producing each of these products. A common material employed to manufacture both products is Ethanol.
This substance accounts for 12% of the production cost and the company currently has only one supplier. In order to guarantee they are getting the lowest cost possible within the market, the Board of Directors commanded the Purchase Department to start a bidding process for a big Ethanol purchase. After the bidding process was finished, the company figured there were two other Ethanol manufacturers nearby that could supply the substance for 10% less than the previous supplier. This measure allowed the company to save 2% of its total cost of goods sold.
