Cost structure
Monster Beverage Corporation is a manufacturer and distributor of energy drinks. The cost structure of the company consists of both fixed and variable costs. The unit price for a can of Monster Energy drink sells at an average price of $7.90.
Variable costs
Monster’s variable costs include the cost of concentrates and beverage bases, the cost of raw materials, re-packing costs and co-packing costs. The company’s raw materials include cans, flavours, containers, bottles, packing materials and ingredients. The table below indicates each of the variable cost items and the respective costs per can of Monster’s Energy Drink.
Contribution margin
Contribution margin is the difference between the unit selling price and the total variable cost per unit (Kampf, Majerčák, & Švagr, 2016). The measure is important in determining the viability of the product or project in the short-run. When the contribution margin is positive, it indicates that the product is viable in the short-run, and any decision to suspend its production will lead to more losses irrespective of whether the company breaks even or not.
Fixed costs
Monster Beverage Corporation incurs fixed costs in its operations. Fixed costs include selling and administrative expenses. It's fixed selling expenses include transport of products to customers, warehousing expenses, advertising, merchandise displays, advertising, sampling and in-store demonstrations as well as sponsorship fees. Administrative expenses include professional and service fees, office rent, supplies, depreciation of office equipment, depreciation of factory equipment and general administrative expenses. The fixed costs are as shown below.
Preliminary break-even point
Break-even point is the minimum number of units Monster Beverage Corporation must sell for it to avoid losses (Kampf, Majerčák, & Švagr, 2016). It is the number of cans of the energy drink that equates Monster Beverage Corporation’s total revenue to its total cost. It is the volume of sales the firm needs to make for its total contribution to offset the total fixed cost. It is given by dividing the annual fixed cost by the company’s contribution margin per unit.
Preliminary break-even point = Total annual fixed cost/Contribution margin
= 425,000,000/3.4
= 125,000,000 cans
Monster Beverage Corporation must sell a minimum of 125 million cans for it to avoid making losses on its operations. The above break-even point is given in dollars as follows:
Preliminary break-even point in dollars = BEP in units × unit selling price
= 125,000,000 × 7.90
= $987,500,000
The break-even point gives an insight as to whether Monster Beverage Corporation’s revenues can cover its production costs and guarantee a given profit level. The break-even point is compared with the current sales volume to determine the margin of safety. If the actual volume of sales is higher than the break-even point, then the product is profitable. A smaller margin of safety indicates the company is at risk of making losses should the sales volume falls.
The concept of CVP analysis can be used in planning and decision making. The management can use the analysis to determine the effect of purchasing a new equipment on the profitability of the company. Besides, the analysis can be used to analyse the effect of introducing a new product line. The new product line changes the average contribution margin thereby affecting the break-even point and the profitability of the company. The impact of an increase in advertising spending among other fixed costs can also be determined using the CVP analysis.
It also assists in managerial decision-making. For instance, the management can analyse the effect of changing the selling price or the variable cost of production on the break-even point and the overall profitability of the firm. This helps in making a decision on the most suitable strategy of increasing profits. A decision that increases the break-even point is not desirable. An increase in the break-even point implies a reduction in the margin of safety thus increasing the risk of making losses.
Despite the above benefits and uses of CVP analysis, it is limited by the fact that it assumes a constant and fixed selling price and variable cost of production. Besides, it assumes that all costs are either fixed or variable. CVP also assumes that there is no inventory since all the production is sold at the end of the period (Catanzaro, 2016). The above assumptions are unreasonable and are not true in most cases. In many firms, it is almost impossible to separate costs into purely fixed and variable costs. There are usually semi-fixed and semi-variable costs which are not considered in CVP analysis.
References
Catanzaro, T. (2016). Break Even Analysis. J Glob Econ, 4(2).
http://dx.doi.org/10.4172/2375-4389.1000190
Kampf, R., Majerčák, P., & Švagr, P. (2016). Application of Break-Even Point
Analysis. Naše More, 63(3), 126-128. http://dx.doi.org/10.17818/nm/2016/si9
