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Sunday, July 25, 2010

Break-even Analysis for Coca-cola Company

Breakeven Analysis at Coca-cola Company

I. The Organization: Coca-Cola Company

Who does not know this leading beverage company? In terms of market share and brand exposure, Coca-cola (hereinafter referred to as the Company or the Organization) has the “say”. It is a very successful organization that almost everyone knows with an asset in the preceding year reaching at least $43 billion in its 2007 consolidated financial statements. Moreover, the net worth of this company is accounted at $27 billion.

As stated in its 2007 Financial report, this beverage organization is the leading name in its line of business that manufactures, distributes and markets non-alcoholic drinks, syrups as well as concentrates. Its products bearing the Coca-cola brand and other brand names under the organization's trademarks have been sold in the United states since 1886 and with great success, are currently being sold in more than 200 countries worldwide.

The organization was incorporated as early as 1919 under the guiding laws of the United States of America, specifically in the state of Delaware. Daily, Coca-cola is serving 1.5 billion of non-alcoholic drinks to its thirsty customers.

The annual Financial information of the organization is available at its website, http://www.thecoca-colacompany.com. It can be specifically found at the following url: http://www.thecoca-colacompany.com/investors/pdfs/form_10K_2007.pdf)

II. Activities of the Organization

Generally, a multi-billion dollar company such as Coca-cola has a long list of activities. In each of its activity, no matter how small it can be in a unit basis, but since there are more than 200 countries to consider, a proper analysis must be taken into account in pursuing an activity or not. Any planned activity must be properly analyze as to its cost versus its benefit.

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One of the notable and fresh act that the organization has decided is in its promotional activities. Last November 11, 2008 Coca-cola has issued a press release on its partnership with the soccer superstar Memo, also known by his complete name as Francisco Guillermo Ochoa. Certainly, this move of the Organization is not a decision that took over for a single night but a long process of research and analysis if this would be of good returns to the Company. A company or an organization like Coca-cola will not succeed to its current status if its decisions are not based on solid profitable grounds. This means that Coca-cola realized that with Memo, it can increase its sales and turn it into profit. This is where break-even analysis comes in.

To give detail to the said decision, and to identify some needed information in making the breakeven analysis a usable tool, the following are identified:

1. Unit of measurement used for the partnership with Memo: This is the length of time the partnership lasts and the extent of activities Memo has to do such services for the Company such as autograph signing, promotions to customers and other promotional procedures in favor of the Organization and its products:

2. Revenue gained through the partnership: Estimated $48 million in sales of memorabilia and more sales of Coca-cola branded products in Latin America are. Each promotional month is estimated to gain $4 million.

3. Variable cost of the partnership: Incremental costs for the following:

(a) customer appearance

(b) Autograph signing

(c) Printed and media promotions (i.e.) $5,000 per hour of any of these activities.

(d) Production cost of the memorabilia related to Memo that are sold

(e) Production cost of the additional sales or Coca-cola branded products resulted by the partnership with memo

4. Fixed cost for the period of partnership: the Contract of partnership for a year amounting to $15 million.

Although these are estimations, once the company recovers the $15 million fixed cost, which is the contract price with Memo and the variables costs that it would incur, Coca-cola will be breaking even with its expense already. That means after breaking even it has to pay only per activity that it must require Memo to perform and the variable cost of the memorabilia and additional product sales. No activity, no cost to incur. Still, at the end of the year, the contract of partnership between memo and Coca-cola proves profitable.

III. Future Activities

Coca-cola surely has lots of plans. One of the possible decisions that it might make, and their respective relevant and irrelevant costs are shown in the following matrix:

Possible Decisions -->

Type of Activities

Contracting every bottling activities out of the company or outsourcing them instead of bottling the products themselves; and

Relevant activities and their costs

1. The current cost of workers' salaries and wages within the bottling division in the Coca-cola company's premises (estimated annual cost, $130 million)

2. The cost of direct materials in making bottles such as glasses, water, chemicals, etc. ( estimated annual cost, $63 million)


Irrelevant activities and their costs

1. Corporate main office lighting and other minor utilities (estimated annual cost, $120 thousand)

2. Salary of the janitors who cleans the main office building (estimated annual cost, $360 thousand)

The above matrix indicates the kind of costs that Coca-cola have. The relevant costs, these will be the direct bases of decsions the Company may make and these costs will be the determining factor if the organization would go on with the plan to outsource or maintain its current activity of having the bottling department inhouse.

On the other hand, the irrelevant costs are the ones that are committed by the entire organization but these costs are not in any way directly related to the issue at hand: the plan to outsource the bottling plants. However, in some cases, these irrelevant costs might be allocated in some way or another in other earning departments. Irrelevant costs are not used in the cost-volume-profit analysis or break-even analysis and eventlually, not used in decision making as the name suggests, it is “irrelevant”.

IV. Allocation of Indirect Costs

SFAS 151 is adopted by the Coca-cola company in treating the costs to be allocated. Its idle capacity, freight and handling costs together with other allocable costs such as spoilage and loss from wastage in production/raw materials are deducted as period costs, which means, they are expensed outright without getting through the inventory stage.

However, in terms of production overhead, such as light, utility and other allocable overhead costs, it is allocated as part of the inventory under “normal capacity” (The Coca-cola, 2008) of production facilities.

The company has a cost of goods sold amounting to $2 billion and allocable total allocable cost is estimated at 10% of the goods sold which means it would reach up to $200 million. What is the implication of this? This means that if the cost is not allocated to the production, they would be expensed outright and would not wait until the goods are sold before they can be accounted for. But in the long run, the same amount will be generated for the bottom amount which is operating income.

Just like most of the companies, Coca-cola uses a peanut-butter costing spreading the costs that are not directly identifiable to those products that could take these costs. It is then a production cost rather than a period cost that is outright expensed.

In a certain organization, just like Coca-cola, there are non-earning departments and these departments are only supporting the main function of the organization. The main function is the department “working for the money” but obviously without the suppost, the money cannot be generated as well. Say, the finance and marketing departments are only supporting the production department. It is the production that “creates” money for the organization. But as mentioned, without the help of finance to properly manage the assets and without the marketing department making the products inetersting and salable, the production department cannot do nothing to earn that money. Thus, it may as well be fair to allocate the costs incurres by these support departments to the the main department. In this case, allocating the cost of non-reveue generating finance and marketing to the production department that mainly generates the sales is viewed as a fair policy. However many prpose the activity-based costing to be more effective because every department has a cost driver that can be considered a fairer valuation of cost for a certain cost center.

V- The Use of ABC- the Activity Based Costing

As mentioned, proponents of ABC argues that this costing system is more useful. As for Coca-cola company, many, if not all of its activities has cost drivers if they need to have a cost.

Talking back about the real situation presented in the firt part (I), the Organization partnering with Memo has many costs and cost drivers. These are the two good examples:

  1. Autograph signing: the very obvious cost driver for this would be the time spent by Memo in signing the autographs of his fans while promoting the Coca-cola products at the same time. Estimated cost of autograph signing in a year, can total to 60 hours paying Memo $5,000 per hour and that would be $300,000 and this is only for authograph signing.
  2. Another cost that Memo can cause the organization would be on memorabilia sales. Say, a T-shirt with his various poses endorsing Coca-cola branded products, memo can bill Coca-cola for it based on the volume of T-shirts printed and sold/given by the company. This means that the cost driver for this “T-Shirt with Memo's image” activity would be the number of T-shirts printed. Estimates number of T-shirts is 5 Million and Memo charges $1.50 per shirt in using his name and image and thus he is entitled 7.5 million payment from Coca-cola.

The above situations, activities and their costs simply indicate the the use of ABC depicts a more accurate result than simply spreading the costs arbitrarily on the products.

Costing a product requires a thorough examination, analysis and understanding of the company's activities. As presented, one might use cost allocation technique or activity based costing.

Reference

The Coca-cola Company Financial Report. (2007). Washington DC. Retriecìved 9 December2008 from <http://www.thecoca-colacompany.com/investors/pdfs/form_10K_2007.pdf>

2 comments:

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  2. thanks! it was a great help for my school project! =D

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