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# Target Profit Analysis:

## Definition and Explanation:

Management desires to achieve a specific amount of profit at the end of a business period. The net operating income or profit that management desires to achieve at the end of a business period is called target profit. To get a target profit management needs to know the business activities for that period.

Cost volume profit (CVP) equations and formulas can be used to determine the sales volume needed to achieve a target profit.

To understand the calculation of target profit consider the following 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 \$75,000 ÷ 0.4 = \$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 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

## Relevant Articles:

 » Contribution Margin » Contribution Margin Ratio (CM Ratio) » Contribution Margin Income Statement » Break-even Point Analysis » Target Profit Analysis » Margin of Safety (MOS) » Operating Leverage » Break even Analysis with Multiple Products » CVP Consideration in Cost Structure » Importance of Cost Volume Profit (CVP) Analysis

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