Cost structure is the percentage of different types of costs in the total costs of a business. Cost structure affects the operating efficiency, profitability and competitiveness of a business. Therefore, identifying and managing the elements that make up the cost structure is very important.

Definition

Cost structure is the percentage of different types of costs in the total costs of a business. Cost structure represents the allocation of financial resources to an enterprise’s production and business activities. Cost structure affects business efficiency, profits and competitiveness of the enterprise.

Cost structure is an important factor in the financial management of a business. A reasonable cost structure will help businesses save costs, increase productivity, enhance competitive advantage and create added value for customers.

Elements that make up the cost structure of a business

Factors affecting the cost structure of an enterprise can be mentioned as follows:

• Business lines: Each business line has its own characteristics in terms of costs. For example, the manufacturing industry has higher variable costs than the service industry, the high-tech industry has higher fixed costs than the trading industry, etc.
• Production scale: The larger the production scale, the lower the ratio of variable costs per product and the higher the ratio of fixed costs per product. This is due to economies of scale and the spread of fixed costs.
• Production technology: The more modern the production technology, the lower the variable costs and the higher the fixed costs. This is due to the substitution of machinery for labor and the increase in depreciation and maintenance.
• Business strategy: A business’s business strategy also affects its cost structure. For example, if a business chooses a strategy that focuses on quality and product differentiation, it will have higher research and development costs than a business that chooses a strategy that focuses on low price and volume.
• Economic environment: The economic environment can cause fluctuations in prices and exchange rates, affecting the costs of businesses. For example, when oil prices increase, transportation costs and electricity bills will increase, when exchange rates fluctuate, import and export costs will change, etc.

What is a reasonable cost structure?

When you start a project, one of the most important factors is determining a reasonable cost structure for the project. Cost structure is how you allocate financial resources to project activities, work, and assets. A reasonable cost structure will help you control costs, optimize profits and ensure project quality.

A reasonable cost structure is a cost structure that helps businesses achieve their business goals in the most effective way. A business’s business goal may be to maximize profits, increase market share, or provide high quality products and services.

A reasonable cost structure must meet the following criteria:

• Suitable for the business characteristics of the enterprise: Each type of enterprise has different business characteristics, so the cost structure of each enterprise is also different. For example, manufacturing enterprises have a higher raw material cost ratio than trading enterprises.
• Consistent with the business strategy of the enterprise: The business strategy of the enterprise will affect the cost structure. For example, a business pursuing a price-competitive strategy will have a higher variable cost ratio than a business pursuing a quality-competitive strategy.
• Suitable for the business’s resources: Businesses need to balance their cost structure and resources. If the cost structure is too high, it will be difficult for the business to achieve its business goals.

You should structure costs carefully and accurately, as well as track and control costs throughout the project.

See more: Shareholders’ equity: Determine business value and investment potential

The relationship between cost structure and revenue

The relationship between cost structure and revenue can be expressed through two important concepts: break-even point and operating leverage. Break-even point is the level of revenue at which pre-tax profit is zero, meaning the business has no loss or profit. Operating leverage is the influence of revenue fluctuations on pre-tax profit fluctuations.

To calculate the break-even point, we have the following formula:

Break-even point = Fixed costs / (Unit selling price – Variable costs per product)

To calculate operating leverage, we have the following formula:

Operating Leverage = Revenue / (Revenue – Total Expenses)

From the above two formulas, we can see the relationship between cost structure and revenue as follows:

• The more fixed costs, the higher the breakeven point and the higher the operating leverage. This means that businesses must sell many products to cover fixed costs and make a profit. However, once the break-even point is crossed, each product sold will yield a higher profit than if there were few fixed costs.
• The more variable costs, the lower the breakeven point and the lower the operating leverage. This means that businesses only need to sell a few products to be able to offset variable costs and make a profit. However, beyond the break-even point, each product sold will yield a lower profit than if there were few variable costs.

Therefore, businesses need to carefully review their cost structure to optimize business efficiency. Some factors that affect the choice of cost structure are business lines, product characteristics, level of competition, market trends, etc.

See more: Develop sustainably financial planning

Some notes on business cost structure

Cost structure is an important factor in business operations, directly affecting business profits. Therefore, business administrators need to pay attention to the following issues regarding cost structure:

• Regularly analyze and evaluate cost structure: Enterprises need to regularly analyze and evaluate their cost structure to promptly detect unreasonableness and take appropriate adjustment measures.
• Strictly control costs: Enterprises need to strictly control costs at all stages, from production, sales to management.
• Find ways to save costs: Businesses need to find ways to save costs in all stages, from using raw materials, labor, to management.
• Increased use of technology: Modern technology can help businesses reduce production, business and management costs.
• Change business strategy: If the cost structure does not match the business strategy, the business needs to change its business strategy.

Cost structure is an important factor in business operations. A reasonable cost structure will help businesses achieve their business goals in the most effective way. Enterprises need to regularly analyze and evaluate their cost structure to promptly detect unreasonableness and take appropriate adjustment measures.