Targe Profit Analysis: Videos & Practice Problems

Target profit analysis is a type of cost-volume-profit (CVP) analysis that helps a business 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 means the business can plan for a realistic profit target instead of just avoiding losses. The key formula for target profit in units is:

This approach allows companies to set sales goals that ensure profitability, making it more practical for business planning.

To calculate the sales in units needed to reach a target profit, you use the formula that adds the target profit to fixed costs and then divides by the contribution margin per unit. The formula is:

For example, if fixed costs are \$15,000, the target profit is \$5,000, and the contribution margin per unit is \(2, then the calculation is:

This means the company must sell 10,000 units to achieve the \)5,000 profit target.

Target profit analysis can also be calculated in terms of sales dollars by modifying the break-even sales formula. Instead of using contribution margin per unit, you use the contribution margin ratio (the contribution margin as a percentage of sales). The formula is:

For example, if fixed costs are \$15,000, target profit is \(5,000, and the contribution margin ratio is 33.3% (or 0.333 as a decimal), then:

This means the company needs \)60,000 in sales revenue to reach the target profit.

A Cost-Volume-Profit (CVP) chart visually represents total costs and total revenues at different sales volumes. The break-even point is where the total revenue line intersects the total cost line, indicating zero profit. For target profit analysis, the chart helps identify sales levels where total revenue exceeds total costs by the target profit amount. The vertical distance between the total revenue and total cost lines at any point represents the profit or loss. Points where total revenue is above total cost indicate profit (shaded green), and points below indicate loss (shaded red). To find the exact sales volume for a target profit, you look for the point where the vertical gap equals the desired profit, such as \$5,000. This graphical method complements the formulas by providing a visual understanding of profit levels at various sales volumes.

Target profit analysis is more useful than simply calculating the break-even point because businesses aim to earn profits, not just avoid losses. The break-even point only tells you the sales volume needed to cover all costs, resulting in zero profit. However, companies usually set specific profit goals to ensure financial success and growth. Target profit analysis incorporates these goals by adjusting the break-even formula to include the desired profit, helping businesses plan how many units to sell or how much revenue to generate to meet their profit targets. This makes financial planning more realistic and aligned with business objectives.