When it comes to calculating cost savings, there’s often a blurry line between *true* savings and *notional* savings. Here’s a quick example to highlight the difference and what to watch out for in these calculations:
Let’s say I wash the dishes and charge my wife £100 an hour for it. She finds that ridiculous, so instead, my son steps in and washes the dishes for £40 an hour. How much money have we actually saved?
The answer might seem obvious, but let’s break it down: no money has actually been saved in the family bank account. We haven’t gained anything we can spend on dinners out, holidays, or anything else.
It’s easy to argue that we’ve saved £60 per hour by choosing the cheaper alternative. However, this is a *notional* saving—it’s just a shift in resource allocation, not an increase in wealth. There’s no *true* financial gain here, just a reduction in cost by changing who performs the task at hand.
In business, it’s essential to distinguish between *actual* savings—where money is saved, such as reducing overheads or increasing efficiency—and *notional* savings, where the only change is shifting resources without increasing profitability.
Best practices when calculating savings:
1. True Savings: Make sure you’re measuring actual savings in terms of cash flow, not just the cost of resource allocation. For example, reducing waste, improving productivity, or lowering overhead that directly impacts your bottom line.
2. Notional Savings: These are useful for internal reporting or comparisons but shouldn’t be mistaken for actual savings. It’s important to communicate clearly that these are “shifts,” not gains.
3. Reinvestment: If cost reductions lead to reinvestment in the business (e.g., you save money on one function, which allows you to improve another area), that’s a *true* benefit to the business and should be calculated accordingly.
In summary, while cost-saving exercises are crucial, always ensure you’re clear about whether you’re calculating true savings or just shifting costs, and when it is internal costs one persons cost reduction is another persons revenue loss.