targetprofit

Target profit is a planning target used in managerial accounting to specify the amount of profit a business aims to achieve in a given period. It is used to guide budgeting, pricing, production, and performance evaluation, and is distinct from a simple break-even point because it includes a desired level of earnings above costs.

In calculations, target profit can be expressed in units or revenue. For a single product, the contribution margin per unit equals price minus variable cost per unit. The required sales volume to reach the target profit is (fixed costs plus target profit) divided by the contribution margin per unit. The corresponding required revenue can be found using the contribution margin ratio, CM ratio, which is the contribution margin per unit divided by the price per unit. Then required revenue = (fixed costs + target profit) / CM ratio. For multiple products, a weighted average contribution margin ratio is used, or budgeting models that allocate fixed costs among products.

Target profit serves several purposes. It informs pricing decisions, production planning, and cost control, and it provides a benchmark for evaluating projects or business performance. It can be incorporated into capital budgeting by comparing expected cash flows against the target profit or required return.

Example: with price 40, variable cost 20, fixed costs 100,000, and target profit 50,000, the contribution margin per unit is 20, so required units = (100,000 + 50,000) / 20 = 7,500. Required revenue = 7,500 × 40 = 300,000. The CM ratio is 0.5, giving required revenue also as (100,000 + 50,000) / 0.5 = 300,000.

Limitations include reliance on stable cost and price relationships and potential neglect of demand uncertainty or risk. Target profit is closely related to concepts like target return on investment and net income targets used in budgeting and decision making.