Now that I’ve talked about Business Models (Model Behavior) and Revenue Models (Making Bank), we need to talk about Cost Structures.

Most entrepreneurs I know are stymied by the question, “What’s your cost structure?”

Honestly, it elicits blanks stares.

Recently, the owner of a small agency told me, “It’s cash versus accrual based, right?”

I gave her an A for effort, but cash and accrual are not cost structure options. They refer to accounting and, more specifically, how you record income and payments.
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If you'd like to learn more about cash vs accrual accounting, drop me a line and I'll write about it in an upcoming email.

In the meantime, back to cost structures.

Your cost structure refers to the different expenses in your business that are necessary to stay in business and drive profitability.

As a result, the cost structure for each company is different, though companies that do similar things will have similar cost structures.

So how do you figure out your cost structure?

1. Write down all your expenses
2. Organize your expenses into different buckets​
   ​For most startups and very small businesses, I recommend the following categories, but use the ones that make the most sense for your business.
   • Product/Service-related
   • Marketing/Customer acquisition (Sales)-related
   • Customer service/support-related
   • Office/General operations-related
   • Staffing/Employee-related
3. Once you've categorized your costs, determine what kind of expense each cost is
   • Fixed — It's always the same no matter what (like rent, or a monthly subscription).
   • Variable — It changes based on how much you produce or sell (like parts or outsourced labor).
   • Mixed — Part of the expense is fixed, but there's also a variable component (like with electricity or different types of banking, shipping, or transaction fees).
   • Recurring or One-time
4. Create a simple visual representation of your costs such as the example here

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It’s easy now to understand the overhead of this business, which is all of the costs other than our products/services expenses.

We can also see where opportunities for cost savings may reside, namely in our products/services, marketing/sales, and even staff/employees categories.

While all of that is tremendously helpful, probably the most critical reason to define your cost structure is because it helps you understand the minimum cost to you of what you’re selling (your cost of doing business as it were), as well as how much you need to earn just to break even.

Learn more about other business model components, including revenue models, channels, and pricing models.

Until next week, remember, the more you know, the better prepared you are to meet the challenges and opportunities ahead.
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