+ Basics

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

The target sales volume required to achieve a specific level of income can be computed using the this 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) |

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:

- A target income of $60,000 before taxes.
- A target income of $60,000 after taxes (40% tax rate).
- 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 |

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.

Key Takeaways

The target sales volume can be derived by tweaking the break-even formulae to incorporate the desired income.

Target sales | = | Total fixed costs + [Target income / (1-Tax rate)] |

CM per unit |

If desired income is expressed in percentage:

Target sales | = | Total fixed costs |

CM per unit - (Percentage x Selling price) |

Web link

APA format

Target profit (2022). Accountingverse.

https://www.accountingverse.com/managerial-accounting/cvp-analysis/target-profit.html

https://www.accountingverse.com/managerial-accounting/cvp-analysis/target-profit.html

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