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Written by Marijn Overvest | Reviewed by Sjoerd Goedhart | Fact Checked by Ruud Emonds | Our editorial policy
Cost Avoidance vs Cost Savings — 3 Crucial Differences
Key takeaways
- Cost avoidance and cost savings offer distinct approaches to financial management.
- Cost avoidance deals with hypothetical future costs while cost savings provide measurable benefits visible in financial records.
- Maximize savings strategically with partnerships, technology, and efficient marketing to drive organizational development.
Saving money is a good way to help the organization achieve its goal. With the additional savings, the organization can use it to purchase or invest in things that will make it develop more. Furthermore, cost savings and cost avoidance are the two ways for an organization to save money. However, what are these?
In this article, we will explain what cost avoidance and cost savings are all about. We will show you its essential characteristics that will help you differentiate these savings from each other.
Once you have read this article, you will have a better understanding of cost savings and cost avoidance. This will allow you which of the two is more effective for your organization. Nonetheless, it will be beneficial for your organization to save money to further its development. So without further ado, let’s check how it differs from each other.
What is Cost Avoidance?
Cost avoidance is a measure that decreases potential increased expenses as a way of lowering the organization’s future costs. To simplify, it is the actions that an organization does to avoid incurring costs in the future.
In cost avoidance, all actions are done to reduce future costs. For example, the organization may spend regularly to maintain the condition of the machines used in production.
Failing to maintain the machines may accelerate their deterioration which could lead to more expensive repairs or worse, needing to replace them.
Letting the employees work on unmaintained machines could increase the chance of accidents happening in your organization which will go far behind the cost of simply repairing the machines.
Any preemptive actions that the organization will do to avoid cost increases in the future are called cost avoidance.
Cost avoidance is not something that you can see or measure in the financial statements or budget of the organization.
Investing in new technology is the most preferable and the winning choice in cost avoidance. This is due to the fact that it eliminates spending on compensation now and in the future.
Value-Added Services
Value-added services are the services that are available at little to no cost that primarily promotes a business.
It is one of the ways businesses can deliver cost avoidance. Through value-added services, companies can avoid the increment of future costs.
Hard Cost and Soft Cost
Hard cost refers to the purchasing price of the hard assets. Therefore, it is a direct cost that is typically tangible that holds some kind of intrinsic value. Examples of this are land, equipment, and facilities. A hard cost is easier to estimate as it is what it is when incurred.
A soft cost, on the other hand, is more inclined to intangible assets of the organization which makes it an indirect cost.
Soft costs are more difficult to quantify because it is difficult to predict or forecast. Also, it cannot be seen on receipts, invoices, or financial records. These are usually reflected in capacity enhancements and cost avoidance measures.
What is Cost Savings?
Cost savings are reflected in both the financial statements and the budget of the company, unlike cost avoidance. It can also be referred to as “hard savings” and is more inclined with actions that decrease debt levels, current spending, or investment.
Cost savings in comparison to previous periods should also be added to financial statements, so the organization can effectively measure cost savings concerning profit over the year.
Cost-saving measures are any action that produces tangible financial benefits that are reflected in the budgets and financial statements of the organization.
Example of Cost Savings
To further understand Cost Savings, here are a few examples:
Partnerships help companies to reduce their costs. For example, partnering with a cloud service provider will get rid of the necessity to build and maintain a computing infrastructure on-premise.
When a contract is negotiated, there is a potential for cost savings. The procurement department can work with potential suppliers to get the best deal whether it is from a reduced overall price for longer contracts or through value-added services.
Having a contract will help organizations to avoid price increases in the long run by locking in a discount for several years.
Price negotiations are another area where procurement can make a huge difference in the budget. For example, if the organization is buying a fixed amount of goods but needs to increase the volume, it may be able to negotiate with the supplier to get a lower price per unit. 1. Partnerships
2. New Contracts and Contract Renewals
3. Price Negotiations
Calculating Cost Savings
For you to calculate your cost savings, take the pre-negotiated cost and subtract it from the final contracted cost. The result will be the number of your cost savings. Here is an equation for you to visualize more:
Pre-negotiated cost – final contracted cost = cost savings amount
If you want to calculate it as a percentage, then here is an equation for you:
Pre-negotiated cost – final contract cost = difference
Difference pre-negotiated cost = Cost savings percentage
Ways to MaximizeCost Savings
Maximizing Cost Savings is what any business aims. Here are a few ways to maximize cost savings:
Outsourcing is becoming a huge trend due to its cost-saving opportunity. Outsourcing can help businesses to cut their operational costs. It proves to be beneficial to small businesses that do not necessarily need full-time employees to effectively run their business.
Many businesses utilize technology due to its capability to lower operational costs and maximize cost-savings significantly. There are numerous online software and solutions that can help your company perform some tasks in your company.
By saving the daily manual efforts of employees into mundane tasks, they can instead focus on using their time to improve productivity in other areas within your business.
Traditional marketing costs have become outdated. There are new forms of advertising that will reach more customers without spending too much on your marketing strategy.
Rather than hiring a traditional marketing agency, your company may use the internet, particularly social media platforms to reach its target audience and gain new customers.1. Outsourcing
2. Technology
3. Lower your marketing costs
What is the Difference Between Cost Avoidance and Cost Savings?
Cost avoidance and cost savings both have a similar purpose for a business or organization which is to save more money. But like what we told earlier they do have their own differences.
The table below are the characteristics of both savings that make them different from each other:
Conclusion
In conclusion, cost avoidance and cost savings offer distinct approaches to financial management. Cost avoidance involves proactive measures to prevent future expenses, often challenging to quantify and not reflected in financial statements.
On the other hand, cost savings yield tangible benefits, readily measurable and visible in financial records. Embracing strategies such as partnerships, technology utilization, and marketing efficiency can maximize cost savings, contributing directly to budgets and financial statements.
Understanding these differences empowers organizations to strategically choose between cost avoidance and cost savings for effective financial development.
Frequentlyasked questions
What is cost avoidance?
Cost avoidance refers to the action that an organization does to avoid incurring costs in the future.
What is cost savings?
Cost savings are more inclined with the actions of the organization that decrease debt levels, current spending, or investment.
What are the main differences between cost avoidance and cost savings?
Cost avoidance does not appear in the financial statements and budget. On the other hand, cost savings are reflected in the financial statements and budget of the organization.
About the author
My name is Marijn Overvest, I’m the founder of Procurement Tactics. I have a deep passion for procurement, and I’ve upskilled over 200 procurement teams from all over the world. When I’m not working, I love running and cycling.
