S21W6 | Costs for entrepreneurs - Cost structure
Hello teacher!!
It's the last week of engagement challenge season 21, how time flies!
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What is a cost structure, and what is its importance for entrepreneurship? |
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Cost structure is a vital foundation of any financial strategy that must be considered. When a business has a good cost structure, good decision making will be easy.
Cost structure is the combination of the total of all different aspects of cost that makes up the expenses of a business. Cost structure of a business may not be the same due to the difference in products.
Cost structure comprises some variables such as fixed cost and variable cost or direct and indirect cost.
Fixed Cost: Fixed costs are those expenses that doesn't change no matter the amount of products produced. That's why the name is called fixed.
Variable Cost: Variable Cost are costs that fluctuates. These cost changes as the amount of production change. This is why they vary.
Direct Cost: Direct Costs are specific with a product or service rendered and can be traced back.
Indirect Cost : These are Cost that needed or necessary to accompany a production. They may not be traced back to product or service.
Provide examples of businesses that use the cost structure methods explained; explain your answers |
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Examples of business that use the fixed cost structure method
Manufacturing companies like Automobile, airlines, Bakeries. All these businesses uses the fixed cost structure. The manufacturing company, airlines and bakeries all pay bills such as salary, business licence, equipment and maintenance, taxes, insurance.
These cost or bills are fixed.. They do not change as cost of production increase or decrease. They are just the same regardless of amount of production.
Examples of business that uses the Variable Cost Structure method
Grocery business, where they sell things like egg, milk, and other food items . Prices of most the items are not fixed. The cost covered in this type of business are cost of shipping these items, cost of marketing it and packaging it. All these costs changes as the quality change.
The furniture companies, these companies needs raw materials to make their products therefore the run cost of materials. When the cost of materials change, the price will definitely change too. Same with direct labour cost.
Another Example is cake business, cost of materials needed to make cake are not fixed, cost changes when the cost production cost changes.
What are the elements of a cost structure? Provide examples |
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The elements of cost structure includes; Fixed cost, Variable Cost, Operating Cost, Indirect cost and Direct cost.
- Fixed Cost
Fixed cost are cost that always remains the same even when production increases or decreases in business. Examples of such are payment of staff salary, and rent of the business. These doesn't change as production change.
- Variable Cost
Unlike fixed cost, this type of cost varies or fluctuates. Variable Cost changes as production changes either increasing or decreasing. Simply put the higher the production, the higher the cost. The lower the production,the lower the cost. Example is the cost of the amount of fuel used in a block industry. If the block industry produce more blocks more fuel will be required.
- Direct Cost
This is the cost that can be traced back to production of a specific product or service. Examples are labour cost, and cost of materials.
Indirect Cost
These are cost that re necessary to accomplish production. Therefore can not be traced back to production. Example of such cost is security cost, rent.
Prepare the cost structure of a business dedicated to making cakes. It has a production of 5 cakes per day and expects to obtain a total profit margin of 25% |
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Fixed cost
| Items | Cost |
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| Rent | $500 |
| Salaries | $150 |
| Purchase of Equipment | $100 |
| Maintenance | $80 |
| Total cost | $830 |
Variable Cost
| Items | Cost |
|---|---|
| Materials for cake | $20 per cake |
| Gas | $2 per cake |
| Electricity | $2 per cake |
| Packaging | $5 per cake |
| Total | $29 |
Total of Cost per month
Since we have 30days in a month therefore;
Total variable cost= 5 cakes x 30 days= 150
150 x 29= 4350
Total fixed cost= $830
Total monthly cost= 4350 + 830= $5180
Profit margin
25% of 5180 = $1295
Total Revenue=Total cost + profit margin desired
5180+ 1295= $6475
To calculate price per cake
Total Revenue ÷ Number of cakes per month
6475÷150= $43.1
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Thank you for reading.