Cost Structure

The types and proportions of fixed and variable costs incurred by the business are referred to as a cost structure. Fixed costs are costs that do not fluctuate depending on how much output a company creates, whereas variable costs change depending on how much output it creates. The idea can be clarified in more modest units, for example, result, administration, client, product offering, division, or geographic district. Cost structure is utilized as an apparatus to decide costs, if associations are utilizing an expense based evaluating procedure, just as to feature regions in which expenses may conceivably be diminished or if nothing else exposed to more readily control.

Whether you’re a retailer or a service provider, you’ll have to pay certain expenses to run your firm. As a result, the cost structure idea is only applicable to management accounting and not to financial accounting. Cost structures contrast among retailers and specialist organizations, accordingly the business ledgers showing up on a budget report rely upon the expense objects, like an item, administration, venture, client, or business movement. 

Even inside a corporation, cost structures might differ due to the different sorts of operations performed by product lines, divisions, and business units. The costs of those items that remain constant regardless of the number of goods and services are known as fixed costs. Then again, the variable expenses are such costs which change in relation to the volume of products or administrations. To characterize an expense structure, associations need to characterize each cost brought about comparable to an expense object.

Example of Cost Structure

The key elements of the cost structures are as follows:

Product cost structure:

  • Fixed costs: Direct labor and manufacturing overheads
  • Variable costs: Direct materials, production supplies, commissions, and piece-rate labor

Product line cost structure:

  • Fixed costs: Administrative overheads, manufacturing overheads, and direct labor
  • Variable costs: Direct materials, production supplies, and commissions

Customer cost structure:

  • Fixed costs: Administrative overheads for customer service and warranty claims
  • Variable costs: Costs of goods and services sold to customers, as well as sales returns and credits

Service cost structure:

  • Fixed costs: Administrative overheads
  • Variable costs: Staff wages, bonus, tax deducted at source, travel, and entertainment

A portion of the first expenses can be hard to characterize, so firms may have to execute a movement-based costing undertaking to all the more intently allot expenses for the expense design of the expense object being referred to. The distinction between fixed and variable costs varies by industry. A service provider may have various forms of fixed and variable costs than a manufacturing unit.

  • Fixed Costs: Fixed costs occur on a regular basis and are unlikely to change over time. Overhead expenditures like as rent, interest expenditures, property taxes, and depreciation of fixed assets are examples of fixed costs. One special example of a fixed cost is direct labor cost. While direct labor costs vary depending on the number of hours a person works, they are nevertheless reasonably steady and can be categorized as a fixed cost, even if hourly workers are more frequently classed as a variable cost.
  • Variable Costs: Variable costs are expenses that change depending on the amount of product produced. Direct labor costs, direct material costs, utilities, bonuses and commissions, and marketing expenses are all examples of variable costs. Fixed costs are more uniform than variable expenses. For organizations selling items, variable expenses may incorporate direct materials, commissions, and piece-rate compensation. For specialist organizations, variable costs are made out of wages, rewards, and travel costs. Costs such as salary and other project expenses are determined by the amount of hours invested in each project in project-based businesses.

For a service provider, a fixed cost for a production unit may become variable. For a manufacturing unit with a set production premise, rent, for example, may be a fixed expense. A service provider, on the other hand, may change offices and godowns based on its needs and requirements. Thus, its lease payout may change each month. The expense structure discloses all expenses brought about to make a plan of action utilitarian. Such expenses can be processed effectively subsequent to deciding distinct advantages, exercises, and organizations. The design can be either cost-driven or esteem driven.

The process of detecting costs spent and then accumulating and assigning them to the appropriate cost objects (e.g., product lines, service lines, projects, departments, business units, and consumers) on a measurable basis is known as cost allocation. Legitimate expense portion is fundamental to recognize and compute the benefits with every item and product offering. An expense pool is a gathering of individual expenses, from which cost designations are made later. Overhead expense, support cost, and other fixed expenses are run of the mill instances of cost pools.

Overpricing will hurt sales and force the company’s items off the market. As a result, the company will lose business to its rivals. Underpricing may boost sales temporarily, but it will eventually cut into earnings. Hence it will lead to erosion of capital. An organization ordinarily utilizes a solitary expense allotment premise, for example, work hours or machine hours, to dispense costs from cost pools to assigned expense objects. Recognizing the expense design and its appropriate assignment additionally helps in discovering which items are generally productive and which are less beneficial.

Knowing the capacity levels associated with the present fixed cost structure can also help a company enhance profits by lowering prices enough to maximize the use of a fixed cost item. Cost-driven plans of action limit costs at every possible opportunity, frequently through a low-value incentive, most extreme computerization, and broad re-appropriating. Though, esteem driven organizations center around a superior incentive regularly with a serious level of customized administration.

Businesses must discover every conceivable opportunity to cut costs in order to increase earnings. While some fixed expenditures are necessary to keep the firm functioning, a financial analyst should always check the financial records to look for potentially excessive spending that add no value to the core business operations. In this manner, a business can then adequately distribute its assets to the creation and offer of more beneficial items. Likewise, an organization can get bits of knowledge on the most proficient method to improve its benefit. It will likewise assist with recognizing the degree to reduce expenses, and it can take restorative choices.

When an analyst understands a company’s whole cost structure, he or she can uncover cost-cutting options that don’t compromise the quality of the items sold or the service provided to customers.  The financial analyst should also maintain a close eye on the cost trend to verify that cash flows are constant and that there are no unexpected expense increases. Businesses can be divided into two groups based on their cost structures:

  • Cost-driven: To stay ahead of the competition, some company models only work and prosper by reducing expenses on a regular basis in their day-to-day operations. A good example of this type of business model is low-cost airlines. To keep expenses under control, such organizations minimize costs wherever possible, retain the smallest feasible inventory, offer low-cost services and proposals, and outsource a large number of operations.
  • Value-driven: The other type of company believes in offering maximum value to its clients, with price being a secondary consideration. A good illustration of this type of business model is luxury hotels. They provide high-end services and products, as well as luxury and style, as well as a high level of personalization and personalized service.

The part of a monetary examiner is to ensure costs are effectively credited to the assigned expense objects and that proper expense portion bases are picked. Both the fixed expenses, for example, the startup and procurement expenses and variable expenses, for example, the month to month working expenses should be represented. It’s worth noting that the majority of firms throughout the world use a combination of the two cost structures described above. The basic goal of most businesses is to provide value to customers at the lowest possible price.

Information Sources:

  1. efinancemanagement.com
  2. accountingtools.com
  3. corporatefinanceinstitute.com
  4. cleartax.in