Cost structure of a company: What is it and how to create it?

In this article we will explain what a company's cost structure is, and why it is so important. When a new company is created, especially the startups that are in vogue, the idea is to produce innovative, creative goods and services that can be easily sold, build customer loyalty and generate an exceptional reputation.

However, few companies take the responsibility of calculating their costs conscientiously. In most companies, this activity is delegated to accountants, auditors and some industrial engineers, who know and respect the issue of costs as a basis for calculating profitability. 

Generating a good return on investment not only requires continuous and high volume sales, but also requires carefully calculated costs, since the price is made up of the costs plus the profitability to be obtained.

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What is a Cost Structure of a Company?

Before defining a cost structure, it is necessary to know what are costs? 

Cost is the measurement and valuation of the consumption made or foreseen by the rational application of factors to obtain a product, work or service. In short, it consists of giving a monetary value to the productive factors: land, labor, capital and technology, which are applied to obtain goods and services.

The cost structure comprises the range of structured and sustained calculations over time, by means of which the company's costs are determined. 

The cost structure is broader than the simple cost of production of goods or services. Interest for access to money, depreciation of goods for use and taxes are also costs to be taken into consideration in the aforementioned structure.

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Related content

• Financial audit of a company
• Financial risks of a company

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Types of Company Costs

Cost, because of its characteristics, is too broad a magnitude to be considered as a whole, and it is therefore necessary to classify costs taking into account various particularities.

Costs by area of origin

Internal Costs of a Company

These are costs that occur exclusively within the company's activity, e.g. direct costs of goods and services. They are usually directly related to the production and sales processes, involving the necessary production factors.

External Costs of a Company

These are costs that occur beyond the business activity itself, for example: taxes payable, service fees, overhead, among others.

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Costs according to variability

Fixed Costs of a Company

These are costs that remain unchanged in the face of variations in the volume of activity in the short term, i.e., that do not imply an increase in the company's installed capacity. 

For example: the payment of rent for the property where the production process is carried out, the payment of services that do not vary according to production, such as municipal taxes or public lighting services.

Variable Costs of a Company

These are costs that vary proportionally according to the level of activity or production of the company. 

For example: machine hours, man hours, units sold, etc. Variable costs are variable in the short and long term, whether or not the company's installed capacity changes.

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Costs according to their function in the company

Company Procurement Costs

These are costs related to the acquisition of inputs and instruments and the hiring of labor to carry out the production process. 

Company Transformation Costs

These are costs related to the production of goods and services that are the object of the business activity. 

For example: machine hours, personnel salaries, electrical energy consumed in production, among others. 

Business Costs of a Company

These are costs related to the distribution, sale and marketing of goods and services. It also includes the costs of after-sales services.

Administration Costs of a Company

These are costs related to management, coordination, planning and control, at a general level in the company.

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Costs according to the application in the company's activity

Direct Costs of a Company

There is an unequivocal and identifiable causality with respect to the object or destination of the cost. No cost allocation method is used. For example: wood and screws to manufacture furniture.

Indirect Costs of a Company

There is no direct causality with the object of the cost and it is subject to proportional distribution among different expense units. For example: electrical energy consumed.

How to calculate the costs of a company?

There is a cost classification that makes it possible to visualize the calculation of a company's costs in an effective way, whatever the main activity carried out. Moreover, this calculation can be carried out continuously over time, and for each of the activities of production or sale of goods and services.

Costs according to the linkage with the company's production process.

Advantages of creating a Cost Structure

Having a solid cost structure in the company, but flexible over time, generates the following advantages, which are not exhaustive:

• It allows to know what productive factors are needed to produce and sell goods or services, from the business idea to the post-sale, facilitating its accounting measurement.
• It facilitates the calculation of the price of goods and services to be sold, at all times.
• It benefits the organization of the flow of resources and funds of the company, to know the amount of each productive factor applicable in time to a certain activity, and the outflow or inflow of money necessary to carry out such activity.
• It generates competitive advantages, since it allows measuring the expected profitability of the sale of goods and services over time, with reasonable certainty in its calculation.
• In companies that operate in multiple jurisdictions or transact internationally, it allows the inclusion of financial components, customs expenses and inflationary factors in the calculation of expected profitability.
• It allows quantifying the production factors required in the short term, but also allows evaluating the possibility of expanding the company's installed capacity and its possible impact on costs and profitability.
• Business plans, tender budgets and due diligence procedures, among others, require the presentation of cost structures to properly evaluate business operations.

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How to reduce costs?

A company's cost reduction depends on several factors, among others:

• The technical characteristics of the good or service.
• The company's target customer.
• The market in which the company operates according to its activity.
• The jurisdictions in which the company operates.
• Risks associated with the activity.
• The legal, financial and tax situation of the company.

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Importance of Risk Management for Cost Reduction

Risk Management through a dashboard, updated 24/7, allows the company to decide which risks it can assume and to calculate the cost not only of these risks, but also of the preventive and corrective measures to be applied.

For example, a company that manufactures wooden furniture may lose its entire production in the event of a fire, in addition to the incalculable human risks. Therefore, it is necessary to take physical preventive measures, such as automatic fire extinguishers, alarms to the fire station and emergency exits, but also financial preventive measures, such as taking out insurance. 

In the same example, the company should be aware of the reputational, legal and economic risks that may be generated by irresponsible logging by the timber supplier, for example. In this case, the risk is associated with third parties linked to the company.

In conclusion, an efficient and timely Risk Management, both its own and that of third parties related to the company, allows to generate a reduction of costs in the short and long term, totally beneficial in terms of profitability, return on investment and corporate reputation.

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