What is a cost structure, and what is its importance for business?

A cost structure means distribution of a company’s expenses by category and is significant in the evaluation of the financial status of an organisation. It determines costs that are attributable with conducting business in areas such as fixed and variable expenses among others. Variable costs are expenses that tend to change over time, the most common of which are rent, insurance and salaries. On the other hand, variable costs change in proportion with the number of units of product produced, this may include raw materials, power and packaging. Many business cases depend on the understanding of a company’s cost structure as it provides the foundation for financial planning and strategic decision-making with respect to regulating expenditures. Another role it plays is tangible in the setting of business price, especially the cost of goods sold, where businesses need to ensure that they are able to charge as much as their cost in order for the cost of even serving the cost of those goods to be met or bettered. In addition, cost structure analysis assists in comparison of a business with rivals with the view of establishing areas for strength, weakness, opportunities and threats. But it is agreed that cost structure has to be analyzed as a survival tool to make sound financial decisions and to survive cut throat competition in the marketplace.

Provide examples of businesses that use the cost structure methods explained; Reason your answers?

1. Software-as-a-Service (SaaS) companies: The subscription model or pay monthly is what these businesses rely on; where people pay a fee on a regular basis to use their software. A common example of SaaS Company is Salesforce.com which offered its customer relationship management (CRM) for accessing by charging fees per month or per year to the customers. It is this cost structure that enable the business like Salesforce to have steady, predictable and stable sources of incomes and expand its operations by attracting more subscribers.

2. Retail businesses: Usually the retail selling firms work on a product mix where they have some costs that remain constant and do not depend on the volume of product sold; they include rent, wages and salaries, and energy charges etc;. For example, Target which is a large retailing company has some overhead costs it has to meet irrespective of the number of items it sells; these overhead costs have to be met the company needs to maintain its stores. This makes Target develop a coherent shopping experience for their customers, and at the same time guarantees that the organization is well equipped to survive.

3. Manufacturers: Cost structure which is used by manufacturers is the process cost which means that cost of production reduces as the number of products produced are large. For instance, the manufacturing business is that of automobiles by Ford Motor Company Company. Ford deems that if it manufactures more cars, the cost of manufacturing each car will be significantly low hence, if Ford manufactures many automobiles, it will more often than not, be more profitable.

4. Subscription-based services: These organizations operate within a model of customer subscription, whereby the client pays a subscription fee to avail a certain service for a certain duration. For instance, Netflix, a subscriber based service, expects its customers to pay a fee per month to watch selected movies or programs. This operational cost model ensures that Netflix is in a position to achieve consistent and steady revenue returns because the consumers keep on paying for the service as they remain clients.
   

   

What are the elements of a cost structure? Provide examples,

A cost structure is simply the categorisation of the various forms of expenditure that a firm has to make in order to do business. The main elements of a cost structure are: Overheads costs can be categorized as fixed cost, variable cost and semi-variable cost.

1. Fixed Costs: It is understood as costs that are incurred irrespective of the level of manufacture and sales. These are costs foreseen for a business operation and are necessary. These are rent, salaries, insurance and depreciation.

2. Variable Costs: These are costs which vary with the volume of production or sales volume in a straight-line proportion. These are fixed expenses which mean that as the production or sales of a business grow, so does this expense. They include costs of bought-in materials, directly attributable employees’ wages, and costs of transportation from the supplier to the factory.

3. Semi-Variable Costs: These costs have a fixed as well as a variable nature attached to them. These are costs that do not change within a fixed level of production but vary as soon as the production level crosses a specific point. An example is the cost of utilities where the cost stays constant to a given level of use, and then varies per unit as indicated below.
   

   

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%.

A cost structure is a model that shows the kind of costs that the firm has to make in order to earn its income.
The elements of a cost structure can be categorized into two main types:
fixed and variable costs.
Here are the main elements and examples of each:

1. Fixed Costs: These costs are likely to be charged even if there is no production or sale at all. They fail to fluctuate in response to fluctuations in production capacity and hence are fixed costs. These include rents, wages and salaries, insurance and depreciation expenses.

2. Variable Costs: Thus, these costs vary with production or sales volumes of a firm or products under consideration. As the amount of production or sales increases, so does the amount of variable costs which will be incurred. Some of them being raw materials, direct wages and packing materials.

3. Semi-variable Costs: Many of these costs are fixed and variable costs in some way. They are fixed up to a certain degree of production or sales; as production or sales volume rises, variable costs begin to rise. They include; tariffs, telephone bills, and maintenance charges among others.

4. Direct Costs: These are those costs that are straightforward to associate with a unique item or activity and include direct labor cost, direct material cost, immediate supply cost and contractor cost. Some of these include raw materials, direct labour cost, and even packaging materials.

5. Indirect Costs:
   They are expenses which cannot be tracked directly to the cost object but compulsory for the business to function.
   Examples include, administrative expense such as the salaries, rent, insurance etc.

6. Overhead Costs: They are indirect costs which may be said to be fundamental for the running of a business. These include administrative wages, rent, and insurance among others.
   

   

In conclusion

Cost structure was explained broadly to encompass fixed costs, variable costs, semi-variable costs, direct costs, indirect costs as well as overheads. These elements help determine a company’s expenses and profits and thus called expense and profit determinants.

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