SLC | S21W6 | Costs for Entrepreneurs - Cost Structure
Introduction |
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From previous lectures till date, we have seen that running a business is not a walk in the park. You need to have a solid understanding of your finances and one of the critical elements that determines success in any business is cost structure.
So, l will be touching on some topics to give you some insights on cost structure. But before going ahead, let me quickly invite @kidi40 @benson6 and @triple-a
What is a cost structure, and why is it important for entrepreneurship? |
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A cost structure is like a roadmap that shows you were exactly your money is going to. It organizes all the money spent in running a business. As a business owner, cost structure helps you understand cost, set prices and make informed decisions.
Importance for Entrepreneurship:
- As an entrepreneur, once you are able to analyze costs, you can set the price for your product to increase your profit margin.
- It helps business owners to be able to detect challenges early and take corrective measures. For instance, it can identify where you are making unnecessary expenses in your business, so you can cut costs.
- It supports growth in business and make sure you are not loosing money.
Provide examples of businesses that use the explained cost structure methods, with reasoning. |
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- cost driven structure
They focus on saving cash to keep their prices of goods as low as possible to attract many customers.
Examples:
Budget airlines like Spirit and Ryanair, will prefer to cut cost by avoiding the extras we see on normal flights like entertainment or free meals. They also add extra seats inside the plane. All this strategies is adopted in order to make their flight tickets as cheap and affordable as possible.
Fast food chains: KFC and McDonald’s use the same recipes all over the world in all their branches. They buy in large quantities and make food quickly. This keeps cost to the barest minimum , in order to sell there food at a very cheap price.
Why?
The purpose of this is to attract as much customers as possible to their businesses. They will rather save money than to use it doing fancy decorations or giving extra service. That way they can pass that savings to the customer at a very low price
- Value-Driven Cost Structure
These are business that concentrates more on producing high quality products or offer luxury services to their customers, even if it cost them more money to make it.
Examples:
Clothing brands like Gucci will charge at a very high price because their clothes are unique and a lot of time is used in decorating their materials.
Personal gym instructor who comes to your house to train you with a different workout plans and routines will charge you at a very high price compared to the price he takes in the gym house for regular members because of the extra attention he gives to you.
Why?
The target of the business is to attract people of high caliber in the society. People willing to pay more for that special services or quality given to them
Identify the elements of a cost structure and provide examples. |
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- Variable Costs
Cost in this category changes based on how much you have produced or sold. The more products you sell, the more variable cost increases, same thing happens when you sell less. So, variable cost directly affects your profit. For instance, business pay commission to their marketers for bringing customers. The more customers they bring, the more commission they get and vice versa
- Fixed cost:
Like the name implies, this are expenses that are fixed, it doesn’t change no matter how much you sell or produce. It keeps businesses running because they cover essential expenses that allows the business to operate. For example, monthly subscription fees for software, shop rent and salaries.
- Direct Costs
This cost are linked directly to producing a product or offering services. With direct cost, it’s easy for entrepreneurs to place a price on a particular product after calculating how much it cost to create each item. Some examples include; cost of materials, equipment needed to produce the goods.
- Indirect Costs
These expenses are not linked directly to any specific products but they keep the business running. Indirect costs. For example, office supplies, electric bills, internet, phone bills. All this costs are divided into all the products.
Prepare a cost structure for a cake-making business producing 5 cakes daily, with a target profit margin of 25%. |
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- Step 1
Variable cost for a cake.
| Ingredients | price |
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| Flour | #4.00 |
| Eggs | #1.50 |
| Sugar | #2.00 |
| Butter | #3.50 |
| Other ingredients like flavor, icing | #3.00 |
| Packaging | #1.00 |
| Total | #15.00 |
Fixed cost
| bills | price |
|---|---|
| Salaries | #100 |
| Utilities | #50 |
| Rent | #100 |
| Equipment maintenance | #25 |
| Total | #275 |
- Step 2:
Variable cost for 5 cakes daily
#15.00 x 5 = #75
Add the fixed cost to it.
#75 (variable cost) + #275 (fixed cost)= #350
- Step 3: Calculate Cost Per Cake
Total Cost for 5 Cakes: #350
Cost per cake : #350 / 5 = #70
- Step 4
Add Profit margin of 25%
Selling Price per Cake = Cost per Cake × (1 + Profit Margin)
#70 x ( 1 + 25%)
#70 x ( 1 + 0.25)
#70 x 1.25 = #87.5
This price ensures you cover all costs and make a 25% profit!
Greetings @sbamsoneu
1.- You have shared the concept and importance of the cost structure for the enterprise, highlighting that it allows to control the resources invested in a productive process.
2.- You have mentioned acceptable examples of companies that adjust to the cost structure methods. You have provided the description of each of these methods, allowing the analysis of all the costs involved.
3.- You have presented the elements of the cost structure, with their respective examples; these allow us to identify the expenses in each functional area of the company.
4.- You have developed the proposed exercise acceptably, performing in detail each of the calculations. We would have liked to see a little more analysis of the results.
Thanks for joining the contest