Target Profit

One of the helpful uses of CVP analysis is the determination of the sales required to generate a target profit (income).

In other words, we can determine the number of units to sell to come up with a desired profit.

This is done by tweaking the break-even formula and incorporating the desired profit.

Target Sales Volume Formula

The target sales volume required to achieve a specific level of income can be computed using the following formula:

Target sales =
Total fixed costs + Target income
 
CM per unit

If the target income is on an after-tax basis, the formula to compute for the target sales would be:

Total fixed costs + [Target income / (1-Tax rate)]
CM per unit

If the target income is expressed in terms of percentage of sales (example, 20% of sales), the formula would be:

Total fixed costs
CM per unit - (Percentage x Selling price)

Example

To illustrate the concepts above, consider the following data.

 
Per Unit
 
Total
Sales (3,000 units)
$15
 
$45,000
Less: Variable Costs
5
 
15,000
Contribution Margin
$10
 
$30,000
Less: Fixed Costs    
20,000
Operating Income    
$10,000

Compute for the sales volume required to attain the following:
1. A target income of $60,000 before taxes.
2. A target income of $60,000 after taxes (40% tax rate).
3. A target income equal to 40% of sales.

1. A target income of $60,000 before taxes

Target sales =
Total fixed costs + Target income
   
CM per unit
     
  =
$20,000 + $60,000
   
10 per unit
     
Target sales = 8,000 units

Analysis: Selling 8,000 units will result in an operating income of $60,000. To prove, let us compute for the net income at 8,000 units.

 
Per Unit
 
Total
Sales (8,000 units)
$15
 
$120,000
Less: Variable Costs
5
 
40,000
Contribution Margin
$10
 
$ 80,000
Less: Fixed Costs    
20,000
Operating Income    
$ 60,000

2. A target income of $60,000 after 40% tax

Total fixed costs + [Target income /(1-Tax rate)]
CM per unit
     
20,000 + [60,000/(1-40%)]
=
20,000 + 100,000
10
 
10
     
Target sales = 12,000 units

To prove, let us compute for the income after tax at 12,000 units.

 
Per Unit
 
Total
Sales (12,000 units)
$15
 
$180,000
Less: Variable Costs
5
 
60,000
Contribution Margin
$10
 
$120,000
Less: Fixed Costs    
20,000
Operating Income    
$100,000
Less: Income Tax (40%)    
40,000
Net Income    
$ 60,000

3. A target income of 40% of sales

Total fixed costs
CM per unit - (Percentage x Selling price)
     
20,000
=
20,000
10 - (40% x 15)
 
4
     
Target sales = 5,000 units

To prove, let us compute for the operating income at 5,000 units. Notice that the resulting income of $30,000 is 40% of the $75,000 sales.

 
Per Unit
 
Total
Sales (5,000 units)
$15
 
$75,000
Less: Variable Costs
5
 
25,000
Contribution Margin
$10
 
$50,000
Less: Fixed Costs    
20,000
Operating Income    
$30,000

Conclusion

Aside from the determination of the break-even point, the CVP analysis can determine the level of sales required to generate a specific level of income. The target income could be expressed on a before-tax basis or after-tax basis. It can also be expressed as a percentage of sales. In all those cases, nonetheless, the CVP analysis can compute for the required sales volume.

Online resource for all things accounting. more
Search this Site
Featured in the Blog
Feedback
Questions, comments and suggestions?
Contact us here.
Copyright © 2016 Accountingverse.com - Your Online Resource For All Things Accounting
Terms of Use | Home | About | Contact