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Home Cost Volume Profit Relationship Target Profit Analysis
 
 

Target Profit Analysis:

Contents:

  1. Definition and explanation
  2. Example
  3. Review problem

Definition and Explanation:

Management desires to achieve a specific amount of profit at the end of a business period. The net operating income or profit that management desires to achieve at the end of a business period is called target profit. To get a target profit management needs to know the business activities for that period.

Cost volume profit (CVP) equations and formulas can be used to determine the sales volume needed to achieve a target profit.

To understand the calculation of target profit consider the following example:

Example:

  • Sales price per unit = $250
  • Variable cost per unit = $150
  • Total fixed expenses = $35,000
  • Target Profit = $40,000
  • Q = Number (Quantity) of units sold

Required:
How many units will have to be sold to earn a profit of $40,000?

Solution:

The CVP Equation Method:

Under CVP equation approach, we can find the number of units to be sold to obtain target profit by solving the equation where profits are equal to target profit (that is $40,000).

Sales = Variable expenses + Fixed expenses + Profit

$250Q = $150 + $35,000 + $40,000

$100Q = $75,000

Q = $75,000 / $100 per unit

Q = 750 Units

Thus the target profit can be achieved by selling 750 units per month, which represents $187,500 in total sales ($250 750 units). This equation is also extensively used to calculate break even point. When break even point is calculated the value of profit in the equation is taken equal to ZERO.

The Contribution Margin Approach:

A second approach involves expanding the contribution margin formula to include the target profit.

Unit sales to attain target profit = (Fixed expenses + Target Profit) Unit contribution margin

This approach gives the same answer as the equation method since it is simply a short cut version of the equation method. similarly the dollar sales needed to attain the target profit can be computed as follows:

Dollar sales to attain the target profit = [(Fixed expenses + Target profit) CM ratio]

= ($35,000 + $40,000) 0.40

$75,000 0.4

= $187,500

No. of units to be sold = $187,500 / $250

=750 units

Review Problem:

Voltar Company manufactures and sells a telephone answering machine. The Company's contribution margin income statement for the most recent year is given below:

  Total Per Unit Percent of Sales
Sales (20,000 units) $1,200,000 $60 100%
Less variable expenses 900,000 45 ?%
 


Contribution margin 300,000 $15 ?%
Less fixed expenses 240,000

 
   
Net operating income $60,000    
 
   

Management is anxious to improve the company's profit performance. Assume that next year management wants the company to earn a minimum profit of $90,000. How many units will have to be sold to meet the target profit figure?

Solution:

Equation Method:

Sales = Variable expenses + Fixed expenses + Profits

$60Q = $45Q + $240,000 + $90,000

$15Q = $3330,000

Q = $3330,000 / $15 Per unit

Q = 22,000 Units

Contribution Margin Method:

(Fixed expenses + Target profit) / Contribution margin per unit

($240,000 + $90,000) / $15 Per unit

22,000 Units

Relevant Articles:

Contribution Margin
Contribution Margin Ratio (CM Ratio)
Contribution Margin Income Statement
Break-even Point Analysis
Target Profit Analysis
Margin of Safety (MOS)
Operating Leverage
Break even Analysis with Multiple Products
CVP Consideration in Cost Structure
Importance of Cost Volume Profit (CVP) Analysis

 

 

 

 

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Financial Accounting Topics


  Introduction to Accounting
 ----------------------------------------------------------------------------
  Transactions and Accounting Equation
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  Analysis of Business Transactions
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  Journal, Ledger and Trial Balance
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  Accounting for Bills of Exchange
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  Special Journals
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  Cash Book
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Bank Reconciliation Statement
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  Final Accounts
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  Work Sheet
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  Capital and Revenue Items
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  Valuation of Inventories
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  Accounts of Non-profit Making Organizations
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  Statement of Cash Flows
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  Accounting Ratios Analysis
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  Depreciation, Provisions and Reserves
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  Accounting Dictionary
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  Financial Calculators
 
 
 
Managerial Accounting Topics

  Financial Statements
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  Cost Volume Profit Relationship
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  Variable Costing System
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  Materials and Inventory Cost Control
----------------------------------------------------------------------------
  Activity Based Costing System
----------------------------------------------------------------------------
  Standard Costing and Variance Analysis
----------------------------------------------------------------------------
  Balanced Scorecard
----------------------------------------------------------------------------
  Capital Investment Analysis/Capital Budgeting
 
 

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