What Is an Avoidable Cost?
An avoidable cost is an expense that won't be incurred on the off chance that a specific activity isn't performed. Avoidable costs allude fundamentally to variable costs that can be eliminated from a business operation, dissimilar to most fixed costs, which must be paid no matter what the activity level of a company. There are occurrences in which fixed costs can be avoidable costs.
Grasping an Avoidable Cost
Avoidable costs are expenses that can be killed in the event that a decision is made to change the direction of a project or business. For instance, a manufacturer with numerous product lines can drop one of the lines, subsequently removing associated expenses like labor and materials.
Corporations searching for methods to reduce or dispose of expenses frequently dissect avoidable costs associated with failing to meet expectations or non-profitable product lines. Fixed costs, for example, overhead, are generally not preventable in light of the fact that they must be incurred whether a company sells one unit or 1,000 units. In any case, in the event that a specific business line uses a factory to make goods and that business line is discontinued, the factory can then stop being rented or can be sold.
In reality, variable costs are not very much avoidable in a short time span. This is on the grounds that the company might in any case be under contract with workers for direct labor or with a provider for direct materials. At the point when these agreements lapse, the company will be free to drop the costs.
Avoidable Cost Strategy
It is to the greatest advantage of all companies to have a cost strategy by which the majority of the costs are avoidable. Businesses ought to frequently conduct a cost analysis of the company and decide how to transfer unavoidable costs to avoidable costs.
The benefit is that in times of financial distress or during economic downturns, a business can adjust and maneuver rapidly by shedding avoidable costs. This could require smoothing out product gatherings, further developing proficiency, arranging shorter-term leases on buildings, or shorter term-leases with providers.
Real World Examples
In 2016, Procter and Gamble (PG) embraced a serious work to defend a considerable lot of its products, disposing of many unprofitable or low-edge brands from its consumer staples portfolio.
Even however fixed cost things, such as building rent, utilities, insurance, certain administrative salaries actually must be paid notwithstanding a reduction in the product count, there were huge avoidable costs associated with those products, for example, marketing and sales expenses and research and development (R&D) expenses, that P&G had the option to eliminate from its operations.
General Electric (GE) is another company that reexamined its product offerings. GE is quite possibly of the biggest company in the world and has different product lines. It is known for its plane engine business, lighting products, kitchen apparatuses, and that's just the beginning. During the economic downturn in mid 2020, which affected travel, GE's most profitable business, its plane engine business was hit hard.
Airline manufacturers, for example, Boeing, encountered a drop in demand for new planes as plane companies saw an emotional drop in movement demand. Thusly, Boeing (BA) didn't require plane engines, which influenced GE. In 2019, 33% of GE's revenues came from aviation, 20% from healthcare, 18.6% from power, and 15% from renewable energy.
As GE was battling it chose to sell its 130-year-old consumer lighting business to Savant Systems. It recently sold its commercial lighting business in 2018. This permitted GE to zero in on its most profitable divisions while shedding failing to meet expectations ones to free up capital by cutting costs and paying off past commitments. While choosing to sell this business, GE turned every one of the costs associated with the division to avoidable costs.
In any industry where price competition drives down profit margins, companies endeavor to recognize however many avoidable costs as could reasonably be expected to work on their primary concern, smoothing out their business to zero in on its core goods and services.
- Businesses ought to endeavor to move however many costs as they can to become avoidable costs, which permits them greater flexibility in times of financial distress.
- By and large, yet not all, avoidable costs apply to variable costs as opposed to fixed costs.
- An avoidable cost is a business expense that can be disposed of by done endeavor the specific business activity.
- A company with different product lines can exit failing to meet expectations ones, in this way eliminating the costs associated with them.