Target profit analysis is one of the key uses of Cost Volume Profit analysis. In target profit analysis we estimate what sales volume is needed to achieve a specific target profit. For example, that what sales would have to be to attain a target profit of 40,000 per month. To answer this question, we can proceed using the equation method or the formula method.
The Equation Method
We can use a basic profit equation to find the sales volume required to attain a target profit. The company has only one product so we can use the contribution margin form of the equation. Remembering that the target profit is 40,000 the unit contribution margin is 100 and the fixed
expense is 35,000, we can solve as follows:
Profit = Unit CM × Q - Fixed expense
40,000 = 100 × Q - 35,000
100 × Q = 40,000 + 35,000
Q = (40,000 + 35,000) ÷ 100
Q = 750
Thus, the target profit can be achieved by selling 750 speakers per month.
The Formula Method
The formula method is a short-cut version of the equation method. Note that in the next to the last line of the above solution, the sum of the target profit of 40,000 and the fixed expense of $35,000 is divided by the unit contribution margin of 100. In general, in a single-product situation, we can compute the sales volume
required to attain a specific target profit using the following formula:
Unit sales target profit = Target profit + Fixed expenses
Unit Contribution Margin
The formula yields the following answer:
Unit sales target profit = Target profit + Fixed expenses
Unit CM
= 40,000 + 35,000
100
= 750
Note that this is the same answer we got when we used the equation method and it always will be. The formula method simply skips a few steps in the equation method.
Target Profit Analysis in Terms of Sales Dollars Instead of unit sales, we may want to know what dollar sales are needed to attain the target profit. We can get this answer using several methods. First, we could solve for the unit sales to attain the target profit using the equation method or the formula method and then multiply the result by the selling price. In the required sales volume using this approach would be computed as 750 speakers × 250 per speaker or 187,500 in total sales.We can also solve for the required sales volume to attain the target profit of 40,000 at the basic equation stated in terms of the contribution margin ratio:
Profit = CM ratio × Sales - Fixed expenses
40,000 = 0.40 × Sales - 35,000
0.40 × Sales = 40,000 + 35,000
Sales = (40,000 + 35,000) ÷ 0.40
Sales = 187,500
Note that in the next to the last line of the previous solution, the sum of the target profit of 40,000 and the fixed expense of 35,000 is divided by the contribution margin ratio of 0.40. In general, we can compute dollar sales to attain a target profit as follows:
Dollar sales target profit = Target profit + Fixed expenses
CM ratio
The formula yields the following answer:
Dollar sales target profit = Target profit + Fixed expenses
CM ratio
= 40,000 + 35,000
0.40
= 187,500
