Target Profit

Definition

Target profit is the desired level of profit that a business aims to achieve through its operations. It is a critical concept in managerial accounting, as it helps organizations set financial goals, make informed decisions, and evaluate their performance.

5 Must Know Facts For Your Next Test

1. Target profit is the desired level of net income or profit that a business wants to achieve, based on its strategic objectives and financial goals.
2. Determining the target profit is crucial for setting appropriate selling prices, managing costs, and making informed decisions about product mix, marketing strategies, and resource allocation.
3. The target profit is used to calculate the required sales volume or revenue needed to reach the desired profit level, considering the company's fixed and variable costs.
4. Achieving the target profit is often a key performance indicator (KPI) for a business, and it can be used to evaluate the effectiveness of the company's operations and management decisions.
5. Target profit is an essential component in the calculation of break-even point, as it helps determine the sales volume or revenue required to cover all costs and reach the desired level of profitability.

Review Questions

• Explain how target profit is related to the calculation of contribution margin and total contribution margin.
  • Target profit is closely linked to the concept of contribution margin, as it represents the amount of revenue needed to cover fixed costs and generate the desired level of profit. The contribution margin per unit, combined with the total contribution margin, helps determine the sales volume required to achieve the target profit. By understanding the relationship between target profit, contribution margin, and total contribution margin, managers can make informed decisions about pricing, product mix, and resource allocation to reach their financial goals.
• Describe how target profit is used in the calculation of the break-even point, and discuss the importance of this relationship.
  • The target profit is a crucial factor in determining the break-even point, which is the level of sales at which a company's total revenue equals its total costs. To calculate the break-even point, the target profit is added to the fixed costs, and this total is then divided by the contribution margin per unit or contribution margin ratio. Understanding the break-even point and its relationship to the target profit allows managers to assess the financial viability of a product or business, plan for profitability, and make strategic decisions to achieve their desired level of profitability.
• Analyze how changes in business situations, such as variations in sales volume, selling price, or costs, can impact the achievement of the target profit through break-even sensitivity analysis.
  • Break-even sensitivity analysis examines how changes in key variables, such as sales volume, selling price, or costs, can affect the ability to reach the target profit. By performing this analysis, managers can understand the sensitivity of the target profit to these factors and make informed decisions to mitigate risks and adapt their strategies accordingly. For example, if a decrease in sales volume would prevent the company from achieving the target profit, managers may need to consider adjusting prices, reducing costs, or exploring alternative product mixes to ensure the desired level of profitability is attained.

Related terms

Contribution Margin:

The difference between a product's selling price and its variable costs, representing the amount that each unit sold contributes to covering fixed costs and generating profit.

Break-Even Point:

The level of sales at which a company's total revenue equals its total costs, meaning it has neither profit nor loss.

Sensitivity Analysis:

The process of examining how changes in one or more variables can affect the outcome of a decision or calculation, such as the impact of changes in sales volume, selling price, or costs on a company's profitability.