Target Profit Analysis: Videos & Practice Problems
Target Profit Analysis extends cost-volume-profit work beyond the break-even point by asking how much a company must sell to earn a desired profit. The key idea is to start with fixed costs and add the target profit, then divide by the amount earned from each unit or sales dollar after variable costs. This makes the analysis more useful for planning because businesses aim for profit, not just zero income.
In units, the central formula is \(\frac{\text{Fixed Cost}+\text{Target Profit}}{\text{Contribution Margin per Unit}}\). In sales dollars, the formula is \(\frac{\text{Fixed Cost}+\text{Target Profit}}{\text{Contribution Margin Ratio}}\). On a CVP chart, the target profit is found where total revenue is above total cost by the desired amount; that vertical gap represents profit.
Target Profit Analysis: Computing Sales
Target Profit Analysis: Computing Sales
Pattigan’s Planes produces model airplanes which sell for \$50 each. Pattigan’s Planes has \$50,000 in fixed costs and pays \$30 in variable costs per unit. If Pattigan’s Planes is targeting \$30,000 in profit, how many units will they need to sell to meet this target?
4000 units
2000 units
1000 units
5000 units
Target Profit Analysis: CVP Chart Method
Target Profit Analysis: CVP Chart Method
Here's what students ask on this topic:
Target profit analysis is an extension of cost-volume-profit (CVP) analysis that helps businesses determine how much they need to sell to achieve a specific profit goal, rather than just breaking even. Unlike break-even analysis, which finds the sales level where profit is zero, target profit analysis incorporates a desired profit amount into the calculation. This is done by adding the target profit to fixed costs and then dividing by the contribution margin per unit or contribution margin ratio. This approach provides a more realistic sales target for companies aiming to be profitable and successful.
To calculate the sales units needed to reach a target profit, use the formula:
This means you add the fixed costs and the desired profit, then divide by the contribution margin per unit (which is sales price per unit minus variable cost per unit). The result tells you how many units must be sold to cover all costs and earn the target profit.
On a Cost-Volume-Profit (CVP) chart, target profit analysis is visualized by the vertical distance between the total revenue line and the total cost line. The break-even point is where these two lines intersect, indicating zero profit. For target profit, you look for the point where the total revenue line is exactly the target profit amount above the total cost line. This vertical gap represents the profit. Identifying this point helps businesses understand the sales volume needed to achieve their profit goals.
To calculate the sales dollars required to reach a target profit, use the formula:
The contribution margin ratio is the contribution margin per dollar of sales (contribution margin divided by sales price). This formula tells you the total sales revenue needed to cover fixed costs and earn the desired profit.
Target profit analysis is more useful than break-even analysis because it goes beyond just covering costs and achieving zero profit. Businesses aim to earn profits to be successful and grow, so target profit analysis helps set realistic sales goals that include desired profit levels. By incorporating target profit into the calculations, companies can plan their sales strategies, pricing, and cost management more effectively to meet financial objectives rather than just avoiding losses.
