What is an Avoidable Expense?
Definition: An avoidable expense, also called an escapable expense, is a cost that is that will not occur if a department is closed, operation is cancelled, or product is discontinued. In other words, it’s an expense that can be avoided by eliminating specific operations.
Management must study avoidable costs when considering downsizing the company, discontinuing products, or relocating operations because these expenses are costs that the company can eliminate if certain action is taken.
If you stopped producing a car, you would no longer have to pay for the raw materials such as steel and aluminium. However, other costs of a firm may be unavoidable, at least in the short term. For example, the firm still has the fixed costs such as rent and paying some safety workers.
For this reason, avoidable costs are often variable costs.
What Does Avoidable Expense Mean?
Even then, sometimes management finds that a factory, department, or branch that continually loses money each period is worth keeping simply because it helps contribute to the unavoidable expenses of the company as a whole. Mergers and consolidations are complex and require careful analysis by management. In the end, the final decision could be left up to management’s judgment about whether the department has future potential.
Avoidable costs are expenses that can be eliminated if a decision is made to alter the course of a project or business. For example, a manufacturer with many product lines can drop one of the lines, thereby taking away associated expenses such as labor and materials. Corporations looking for methods to reduce or eliminate expenses often analyze avoidable costs associated with underperforming or non-profitable product lines. Fixed costs such as overhead are generally not preventable because they must be incurred whether a company sells one unit or a thousand units. In reality, variable costs are not entirely avoidable in a short timeframe. This is because the company may still be under contract or agreement with workers for direct labor or a supplier of direct materials. When these agreements expire, the company will be free to drop the costs.
In general, a variable cost is considered to be an avoidable cost, while a fixed cost is not considered to be an avoidable cost. In the very short term, many costs are considered to be fixed and therefore unavoidable.
From a risk management perspective, it is useful to periodically review the cost structure of a business and try to shift as many costs as possible from the unavoidable to the avoidable category, which gives management greater room to maneuver if the business suffers a revenue shortfall and must cut back on its expenses. For example, a lease can be renewed with a shorter term, so that management has the option to cancel the related expense within a shorter period of time than had previously been the case. As noted in the example, the general strategic approach to dealing with avoidable costs is to commit to shorter time periods for any planned expenditures.
Example
For example, if a factory is performing poorly and continually losing money each quarter, management might consider consolidating the department or eliminating it altogether. Before the drastic decision is made to close a department or branch, you have to look at the costs that will be eliminated.
Let’s assume a manufacturer is considering closing one of its factories. What expenses would be eliminated if the factory closed? The company would not incur the salaries, rent, utilities, and depreciation of equipment related to the factory when it is closed.
Other expenses that affect the company as a whole like advertising, insurance, administrative expenses, and general expenses would all still be present. These are considered the unavoidable costs because the company can’t get rid of them even if they close the doors to the factory.
The decision to close the factory is a balance between the avoidable expenses that will be eliminated and the unavoidable costs that will remain. This decision ultimately comes down to whether or not the factory’s revenue is less than the avoidable expenses.