How to identify hidden costs in your company

Keeping control of costs is fundamental to directing a company towards success. However, it is not always so easy to achieve because it requires exhaustive supervision of the processes that are being developed, and that often mask situations in which part of the merchandise is lost because it was oversupplied and, then, the costs of that lost merchandise is not recovered or turned into a profit.

As the name implies, hidden costs are those that are involved in the production or management of a business and are difficult to identify. Depending on their nature or magnitude, hidden costs could lead us to make the wrong decisions about prices or business results.

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If you are wondering how they are generated, the answer may be complicated since the causes can be several. For example, a failure in the execution of the processes can trigger not only the delay of the task but also the leakage of costs where the underlying problem manifested itself. A batch lost due to poor quality is also a source of hidden costs.

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Another cause for hidden costs is miscalculations regarding the total cost of a batch or production and the lack of monitoring of actual production volumes about the reported volume in inventory.

Since it is so difficult to detect these hidden costs when they appear in the expenses of a company, we show you easily and practically how to identify them.

Where do they manifest and how to identify them?

• When there are inventory levels higher than necessary.

Whether it's raw materials or finished goods, the hidden cost here is financial, because inventories are "money tied up" until they're used in production or put up for sale. In this sense, the higher the inventory level, the more money will be immobilized that could be used for different needs of the company and instead remains stagnant.

High inventory levels are often caused by poor production or sales planning and could lead to "product obsolescence" (meaning when products become out of date or expire and drop in status because cease to be marketable) if they lose their opportunity to be sold.

• When high-quality materials are used for a product that competes in a low-priced market.

High-quality materials may be used to make a product but the product competes in a low-price market. Then, the consuming public will probably opt for those conventional products that satisfy their needs immediately and at a lower cost, if in this case, their quality is not a determining factor in deciding on the best.

• When in technical service, it's done more than budgeted.

Likewise, it often happens that an estimate is made of what a budget should cost in technical service, for example, but it turns out that once the work is done, the specialist realizes that the time or the service performed itself were higher in compared to the agreed amount.

Consequently, it is very feasible that the technician has to stick to the original budget, being aware of the loss in his/her profit, but thus avoiding leaving a dissatisfied or upset customer if he/she had charged more than expected.

• When production has to be stopped due to mechanical failure because of poor maintenance.

Mechanical failures represent production delays and lost work hours, at best. In the worst case, the lost production involves production batches from the food industry. Unexpected failures in machinery are frequently caused by a lack of preventive maintenance.

• When inappropriate means of mobility are used.

In this case, hidden costs are generated in the case of those products whose means of transport could cause them damage, if the necessary measures are not taken with vehicles equipped to transport certain products according to their permanence needs.

• When transfers of unnecessary merchandise are generated.

Whether these transfers are generated within the plant or to their next destinations, which can be the different shopping centers, they constitute movements that produce hidden costs, because they require personnel to carry them out. As in the previous case, they represent a cost risk for production if they are damaged during transit, and consequently, it will imply a greater delay in production, which will inevitably cause additional expenses.

How to prevent these hidden costs from harming the profitability of your company?

As we pointed out previously, it is very difficult to control the total production or even the resources that are distributed in each area for its different functions.

It takes not only thorough supervision, but also a relationship of trust and sincerity between the teams to assume their own mistakes, when there are any, but also enough honesty to declare any fraudulent movement inside or outside the company, which does not is duly remitted in the cost records.

In these cases, if the person responsible is found, an exemplary sanction will be applied, depending on the seriousness of the action and the economic damage suffered by the organization. However, there are still some less punitive alternatives that can be implemented, especially when hidden costs manifest due to a lost production batch:

• Improve supervision: detect operators who made the mistake and encourage them to pay more attention to the work they do, since the success or failure of a company's business also depends on them.
• Survey the processes: it will seek to correct the failures that caused the problem.
• Adjust costs: If necessary, the usual costs will be reduced based on the raw material or production discarded.

Some more alternatives or solutions may be implemented, but everything will depend on the specific problem that caused the hidden costs, since, in each case, all the variables must be analyzed, the pros and cons, of executing an action aimed at remedying problems. It's vital to identify them, and after that, determine which will be the exit routes that best safeguard the interests of your company.