Target Profit Analysis:
Definition and Explanation of Target Profit:
Target profit is the amount of
net operating income or profit that
management
desires to achieve at the end of a business period.
Management needs to know the required level of business activities to get
target profits.
Cost volume profit (CVP) equations and formulas can be used to
determine the sales volume needed to achieve a target profit. The explanation of
target profit analysis requires an 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
= $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
format 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 |
|
