Cost justification is a substantiation of the need for an item of expenditure, with documentary or any other evidence. Business owners or managers may require the person incurring the cost to explain the reasons for doing so, and expect proof that expected returns would exceed the cost. All expenditure of substantial nature, not included in the annual budget require such cost justification. At times, even items mentioned in the budget may also require a justification to ensure optimal utilization of monetary resources.
Download a free cost justification template here. This template is generic, and suitable for any type of expenditure. Customize it to suit your requirements.
The following elements should be included in any standard cost justification
- Why is the cost unavoidable? No business likes to spend money on anything unnecessary, for expenditure means lesser profits or revenues. The cost justification needs to substantiate why the cost is necessary, and not avoidable. Possible reasons include statutory compliance, indispensability for operations, importance to establish dominance over competitors, or anything else
- Alternatives: When the cost incurred is to resolve problems or take advantage of some opportunities, there would invariably be many approaches. List out all such ways and explain the reasons for selecting an approach. One way to do so include performing a lifecycle cost analysis.
- Direct benefits: The most important part of a cost justification is the perceived benefits resultant from incurring the cost. Undertake a cost benefit analysis to determine the returns or savings expected by making the investment.
- Indirect benefits: Many times, incurring the cost provides some indirect benefits that may make the proposal more attractive. Such indirect benefits may not relate directly to the benefits, and may be difficult to quantify. For instance, installing an automatic attendance tracking system may automate the process and provide direct benefits such as better control over timekeeping and reduced work for the HR team, and also indirect benefits as employees coming in a bit early and leaving a bit late to avoid being caught by the automatic time-stamp. Brainstorm to unearth such indirect benefits.
- Who will benefit? List the major beneficiaries. For instance, incurring the costs of ergonomic chairs may benefit the company indirectly by increasing productivity, but the primary beneficiary is the worker. Generally, approval becomes easier when more people benefit. By when will the benefits realize? The benefits of some spending activities manifest immediately. The benefits of other spending activities, such as providing a training program on developing employee soft-skills, come in the long-term. Wherever appropriate, determine the present value of the expected results, or the future value of the investment, to allow decision makers incorporate the time value of money when making the decision.
- Timeline: Provide a comprehensive and detailed description on the expenditure. Incorporate timelines for spending the money or implementing the project in stages.
- Spill-over effects: Clarify whether the cost leads to any other follow up costs. For instance, new machinery would require additional payments on energy charges to operate the machine and annual maintenance charges. Sometimes, the inverse may also be true, and the investment may lead to reduction or elimination of some existing cost. For instance, new replacement machinery may come with free service during the guarantee period, doing away with the annual maintenance costs incurred on the now obsolete machine.
- Nature of the costs: Specify whether the cost is one-off or recurring. For instance, an insurance premium is a yearly commitment, whereas designing a new corporate logo is one-time expenditure. Similarly, clarify whether the cost is one-off or part of some other big expenditure. For instance, purchasing a new Energy-Star rated monitor may be part of a larger green initiative for which a separate budgetary allocation may exist.
The sample template lists the twelve key inclusions in a cost justification, followed by the route the proposal follows in the organization. The employee forwards the justification form to the supervisor, who makes a recommendation and forward the same to the finance department. The finance department may make the recommendation based on availability of finance rather than any technical consideration. The business owner finally approves or rejects the proposal after considering all factors and various inputs.
Like the elements in the template, this process flow is also flexible. For instance, the supervisor may return the form to the employee for any changes. Upon rejecting the proposal, the supervisor may simply forward the same to the business owner after noting down his objections, allowing the business owner to have the final say.
- “Warehouse Management System: Cost Justification.” https://www.idii.com/wp/kom_wms_justification.pdf. Retrieved July 24, 2011.
- Arnett, Stephen. “Project Cost Justification.” https://www.qualitydigest.com/apr99/html/body_teams.html. Retrieved July 24, 2011.