Cost Structure Example Startup: Everything You Need to Know
The cost structure example startup refers to the types of business cost structure that will impact the success of a startup.3 min read
The cost structure example startup refers to the types of business cost structure that will impact the success of a startup. The major components of such cost structure are variable and fixed costs. Variable costs are costs that change in direct proportion to production/selling activities. Examples include sales commissions, product cost, cost of labor and raw materials used in manufacturing, etc.
Conversely, fixed costs are those that occur irrespective of the volume of selling or business activities. They are costs that accrue due to the passage of time such as insurance, salaries, and rent.
How to Determine if a Cost is Fixed or Variable
Identifying the variable or fixed costs is simple — all you need to do is determine the costs that vary with the volume of selling or production activities in your business. If the cost varies, then it is variable — if not, it is fixed.
To an extent, a business' cost structure is fixed by virtue of the type of industry and nature of business operations. However, there are decisions that can directly influence the split between variable and fixed costs.
Importance of a Business' Cost Structure
When starting a business, there are lots of things to consider including
- writing a comprehensive business plan
- choosing a business structure, business name, and office location
- acquiring capital
The start-up costs play a huge role since your business will not take off without the right amount of capital. By estimating your start-up costs, you can determine if your business plan is feasible and the amount of financing you may need.
Some individuals presume that as long as a business makes the same volume of profit as another business with similar operations, the cost structure they implement do not matter. However, an analysis into what happens to a business' break-even point when there are changes to its cost structure reveals the difference.
Let's consider two start-up businesses, Company A and B. The fixed cost structure for Company A is high since the company plans to commence business operations by investing heavily in production equipment, machinery, and facilities for manufacturing and distributing its own product. Although this decision leads to a lower variable cost, the downside is a much higher fixed cost.
On the other hand, Company B is proposing a lean start-up. It plans to outsource distribution and manufacturing operations to a third-party concern. As such, it needs lesser investment in office facilities, equipment, and machinery, leading to a lower fixed cost. However, its variable costs are much higher since payments must be made to the third party handling its manufacturing and distribution operations.
Let's assume that each Company, based on its operational structure, sells 6,000 units of its products with similar selling price (12.00), total costs (65,000) and profits (7,000). With this information, the break-even point for each company can be calculated using this formula
Break-even sales = (Fixed costs / Gross margin) %
while the break-even units can be obtained using this formula
Break-even units = Break-even sales / Selling price"
After the calculations, it is observed that although everything is the same, the different cost structure of each company results in different break-even positions.
For Company B with a lower fixed cost structure, they only need to sell 3,083 units at the selling price of 12.00 to break even while Company A, needs to sell 5,028 units to reach its break-even point.
As such, Company A needs to sell 63 percent more units than Company B to reach break-even point due to its high fixed cost structure.
Benefits of Reducing Fixed Costs
This means that when making financial projections for a new business, it's best to keep fixed costs to the barest minimum so that the break-even point can be reached much sooner.
When defining a cost structure, always check the cost attributed to the key elements of your business operations. By pinpointing the most expensive and crucial elements, you can identify the most crucial costs to your business model.
This enables you to determine if your business is more cost-driven or value-driven. However, it must be noted that some costs may reduce as your business continues to grow. This can be attributed to economies of scope and economies of scale.
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