Target Profit Analysis: Videos & Practice Problems
Target Profit Analysis is a cost-volume-profit approach used to determine the sales needed to earn a desired profit rather than just reach the break-even point. It builds directly on CVP analysis by adding target profit to fixed costs. In units, the key formula is \( \frac{\text{fixed costs}+\text{target profit}}{\text{contribution margin per unit}} \) . This shows how many units must be sold to achieve the profit goal.
Target profit can also be calculated in sales dollars using the contribution margin ratio: \( \frac{\text{fixed costs}+\text{target profit}}{\text{contribution margin ratio}} \) . On a CVP chart, the break-even point is where total revenue equals total cost. Any point above break-even has positive profit, and the target profit is found where the vertical gap between total revenue and total cost equals the desired amount.
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
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Target profit analysis is a type of cost-volume-profit (CVP) analysis that helps businesses determine the sales volume needed to achieve a specific profit goal, rather than just breaking even. While break-even analysis calculates the sales level where total revenue equals total costs (resulting in zero profit), target profit analysis modifies this by adding the desired profit to fixed costs in the formula. This allows companies to plan for actual profitability. The key formula for target profit in units is: . This approach provides a more realistic sales target for business success.
To calculate the sales units needed to reach a target profit, you use the formula: . This means you add the fixed costs and the desired target profit, then divide by the contribution margin per unit (which is sales price per unit minus variable cost per unit). For example, if fixed costs are \$15,000, target profit is \$5,000, and contribution margin per unit is \$2, then the required sales units are (15,000 + 5,000) / 2 = 10,000 units. This tells the business how many units must be sold to achieve the profit goal.
On a CVP chart, total cost and total revenue are plotted against sales volume. The break-even point is where the total revenue line intersects the total cost line, indicating zero profit. For target profit analysis, the goal is to find the sales volume where the vertical distance between total revenue and total cost equals the target profit. This means total revenue is higher than total cost by the amount of the desired profit. Areas where total revenue exceeds total cost represent profit (often shaded green), while areas where total cost exceeds total revenue represent losses (shaded red). Identifying the exact point for a specific target profit requires knowing the equations or data points for total cost and revenue.
The formula to calculate the sales dollars needed to achieve a target profit is: . Here, fixed costs and target profit are summed in the numerator, and the denominator is the contribution margin ratio (contribution margin per dollar of sales). For example, if fixed costs are \$15,000, target profit is \(5,000, and the contribution margin ratio is 33.3% (or 0.333), then sales dollars needed are (15,000 + 5,000) / 0.333 = \)60,000. This tells the business how much revenue must be generated to meet the profit goal.
Target profit analysis is important because it helps businesses plan beyond just breaking even. While break-even analysis shows the minimum sales needed to avoid losses, target profit analysis sets realistic sales goals to achieve desired profitability. This allows companies to make informed decisions about pricing, cost control, and sales strategies to meet financial objectives. By understanding how many units or sales dollars are needed to reach a profit target, businesses can better allocate resources and evaluate the feasibility of their goals.
