As a business matures and stabilizes, it’s common for management to begin planning the company’s goals, with the most common being profit. The term for this is called Target Profit, and here we will discuss the planning and formulas to help you begin this process.
Target Profit Definition
Target profit analysis refers to the anticipated amount of profit the business managers expect to earn in a certain accounting period. Target profit is typically calculated in the budgeting process and is often compared with the income statement from a previous accounting period.
To set a target level of profit, historical financial results are reviewed in addition to future forecasts. There should be some constants, such as overhead costs or variable expenses and break-even point, to help with the planning process.
As a way to calculate how many units a company needs to sell, the target profit calculation was created.
Target Profit Calculation
| Sales (units) = (Target Profit + Fixed Costs) / Contribution margin per unit |
For this example, the important assumption or assumptions being determined is that the next quarter’s target income is that dollar sales of $250,000 and fixed costs are estimated to be $150,000.
The next calculation that needs to be made is determined by using the contribution margin cm method. If we have a unit price of $100 and a variable unit cost of $60, the contribution margin is $40 per unit.
To figure the quantity of units that are needed to reach the necessary sales level for the target profit point, we finish the calculation by using the following key formula:
| Sales (units) = ($250,000 + $150,000) / $40 = $10,000 units |
The following contribution margin income statement can be used to double check the math:
| Sales (10,000 units X $100) | $1,000,000 |
| (-) Variable Costs (10,000 X $60) | $600,000 |
| Contribution margin (10,000 X $40) | $400,000 |
| (-) Fixed Costs | $150,000 |
| Operational Income | $250,000 |
With the target profit calculation of $250,000 and the estimated fixed product costs and contribution margin, this company would need to sell a quantity of 10,000 units. With this information, management can set the sales team’s goals and ensure the company’s production meets the required sales volume to meet the monthly profit for the target net income.
