When it comes to understanding how your alcohol brand is performing and establishing different metrics for success, there are a lot of different formulas and equations that can be used. The cost-volume-profit (CVP) analysis is just one option. This approach to cost accounting looks at how costs and volume impact overall profit. The goal is to determine the break-even point for cost frameworks and sales volume. Performing a CVP analysis requires using several different equations and plotting the results on a graph. Since this can get a little complicated, we’ll provide a breakdown of how to run a cost-volume-profit analysis for your alcohol brand.
COVID-19 has had a major impact on the beverage and restaurant industries, which has forced managers to make difficult short-term decisions to keep doors open. A cost-volume-profit analysis can be an important tool in this decision-making process. It is useful in revealing how adjustments to both variable and fixed costs can affect a brand’s profit. Running a CVP analysis is the best way to determine how many units of product need to be sold to break even in terms of costs or to meet a certain profit goal. This information can influence production, commercialization, marketing, sales strategies, and other aspects of a brand’s operations.
Main Elements of a Cost-Volume-Profit Analysis
Essentially, a CVP takes a closer look at how three essential elements affect profit. The goal is to estimate how much profit will be affected when there are changes to costs, sales volume, and price. Because all of these elements can be variable, there are different calculations that need to be performed to better understand how each element impacts your bottom line.
Featured Resource: Sales 101 For Alcohol Brands
How to Calculate Cost-Volume-Profit Analysis
Contribution Margin
To begin, you will want to find your company’s contribution margin income statement, which highlights the difference between sales and variable costs. This equation requires understanding both fixed and variable costs. To put it more simply:
Operating income (or net income) = Sales – Total Variable Costs – Total Fixed Costs
Or
Operating Income = (Price x #Units Sold) – (Variable Cost Per Unit X Number of Units Sold) – Total Fixed Costs
Gross Margin Vs. Contribution Margin
Then you will need to factor in both gross margin and contribution margin, which are two different measurements. The gross profit margin represents the difference between the cost of products sold and the total profit on sales. When looking at costs, it is important to take into account both fixed and variable costs. The contribution margin, on the other hand, only takes variable costs into account. Understanding both of these margins is important as they provide different insights.
Contribution Margin Ratio
Determining your contribution ratio means calculating the percentage your contribution margin represents of total sales. This ratio is key to understanding the earning potential of your alcohol brand. For example, if your contribution margin is $45,000 and you have earned $100,000 in sales, your contribution margin ratio is 45%. Essentially, for each additional dollar in sales, you will need to prepare for a $0.45 increase in the contribution margin in order to adequately cover fixed costs.
Calculating the Break-Even Point in Units
It is also important to understand how many units will need to be sold in order to reach a point where revenue is equal to expenses. Ultimately, the goal is to reach a positive operating income and earn a healthy profit. The cost-volume-profit analysis looks at how increasing prices, a change in fixed costs, or volume affect the break-even point.
Example of an Alcohol Producer Using a Cost-Volume-Profit Analysis
The spirits producer Brown-Forman is constantly dealing with the impact of climate and agricultural changes on their business. As a result, they need to have an accurate idea of how many units they will need to break even. At the same time, sales volume of wine and spirits is also subject to seasonal trends. In addition, crop yield can be the deciding factor in the amount of supply that can be produced. A CVP analysis helps Brown-Forman determine how many units they need to sell or if a price change needs to be made. Typically, spirits producers tend to run a tight ship when it comes to keeping fixed costs low, so adjusting this area might not always be possible.
Since Brown-Forman produces various types of spirits that all require different ingredients, their CVP calculation can become complex. From harvest numbers and labor demands to production requirements and packaging costs, there are a lot of different factors to take into account. However, crunching the numbers is an important part of not just breaking even, but turning a healthy profit that helps an alcohol beverage brand stay in business.
If your beverage alcohol brand has been heavily focusing on marketing efforts and other field activity operations and not seeing the anticipated return, it may be time to conduct a cost-volume-profit analysis. This will provide you with a more accurate picture of the main elements of your business and some insight into how adjusting one or more aspects could help or hinder your profits.
FAQs
What is cost-volume-profit analysis?
Cost-volume-profit analysis is a type of business accounting that looks at how varying unit prices and volume will affect profit. The goal is to first determine the break-even point.
How do you calculate cost-volume-profit analysis?
Operating income (or net income) = Sales – Total Variable Costs – Total Fixed Costs
What is the use of CVP analysis?
The point of a CVP analysis is to determine how changes in variable and fixed costs will affect profits.
What are the three elements of cost-volume-profit analysis?
The three main elements are cost, sales volume and price. A CVP analysis looks at how these elements influence profit.
How can an alcohol producer use cost volume profit analysis?
An alcohol producer can use a CVP analysis to determine the number of units required to break even or whether a price change will be the most beneficial option to increase profits.
