As a business matures and stabilizes, it’s common for management to begin planning goals for the company, 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 beginning this process.
Target Profit Definition
Target profit refers to the anticipated amount of profit the managers of a business 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 profit, historical financial results are reviewed in addition to future forecasts. There should be some constants such as overhead costs 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, assume that the target profit for the next quarter is $250,000 and fixed costs are estimated to be $150,000.
The next calculation that needs to be made is the contribution margin. If we have a unit price of $100 and the variable unit cost of $60, the contribution margin is $40 per unit.
To figure the number of units that need to be sold to reach the target profit, we finish the calculation:
|Sales (units) = ($250,000 + $150,000) / $40 = $10,000 units|
An 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)
|Contribution margin |
(10,000 X $40)
|(-) Fixed Costs||$150,000|
With the target profit calculation of $250,000 and the estimated fixed costs and contribution margin, this company would need to sell 10,000 units. With this information, management can set the sales teams goals and ensure manufacturing can produce the necessary output.