What is Target Profit?
Target Profit is the estimated amount of profit that the management hopes to achieve during an accounting period and is forecasted and updated regularly as per the business’s progress.
Target Profit Formula
This formula is derived by evaluating the company’s situation so that the company will achieve the break-even point where the company is able to bear the fixed cost of the business expenditure and cover the necessary variable cost. For the same, the revenue needs to be achieved for attaining target profit can be illustrated as;
Where,
- Revenue = The Revenue or Sales amount need to be achieved for attaining target profit
- % of Gross Margins = It denotes the percentage of profit is to be gained from the sales amount
The above formula will provide the sales amount, and if total sales unit is to be found, then the same formula could be;
Examples
The management of a company name ABC Inc. after finalizing the target profit to be achieved in the next quarter, wanted to equate the sales revenue that would be needed. For the evaluation of the revenue required following information is made available. Comment on the sales required.
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- Target Profit = $ 1400000
- Fixed Cost = $ 210000
- % of Gross Margin = 70%
By putting these values in this formula we can evaluate the sale revenue required:
- = 210000 + 1400000 / 70%
- = $2300000
Hence for making a target profit of $ 1400000 in the next quarter, the company needs to make a sale of $ 2300000 with a 70% gross margin.
Target Profit Analysis
Target analysis is a small part of cost volume profit analysis, which is a wider concept. This covers the evaluation of the sales level, or the amount of revenue needs to be generated to earn a targeted profit after covering the fixed overhead expenditures as well as variable overhead expenditure in the targeted period. This is the next step for the organizations after the break-even platform where the revenue from the sales only able to cover fixed & variable overhead without any profit, but in the target profit analysis, the target of the company is to earn the targeted profit over and above the expenditures.
Advantages
- It provides less variation with the actual results as compared to the budgeted profit. It tends to more reliable. As well as the target profit gets updated as per actual results, it becomes more feasible and reliable to use.
- It provides a detailed analysis of the cost structure of the business as it includes the Fixed cost structure as well as the variable cost structure of the asset. The incorporation of the selling price & cost of the asset for the evaluation of the gross margin percentage also shows the profitability of the company. So, this also helps in the overall evaluation of the profit-making capability of the company.
- It also helps the management in taking the decision making regarding the business operations and finalizing the mission and goal of the company for the upcoming periods. This analysis can help in predicting the capability and help in making the decision-making process.
Disadvantages
- The variation is less, but the system is open to manual errors or mistakes. As the calculation of the gross margin calculation and the intakes of the variable overheads are to be incorporated by a person, so there are chances of error in calculation, and that may lead to inaccurate results or projection.
- Since this analysis required updates on a regular basis, so this could sometimes become serious and hectic tasks for the team.
Conclusion
Overall the target profit analysis helps the company to identify its mission for the targeted period through evaluation of the company’s overheads and profit-making ability. The usage of this method has been increased and adapted from large profit-making companies to the dormant one. The regular update of the existing scenario helps it to be a realistic analysis and more accurate so as to show low variation as compared to actual results.
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