Target Income or Profits
The break-even analysis is crucial for the management to set target income or target profits. Sometimes managers desire a given target income or revenues. They accomplish this by using the break-even analysis.
This is achievable because once a company determines the break-even point which covers all the costs (variable and fixed), the surplus over the break-even amount becomes pure profits.
To understand how the management can calculate the target income, it is important to remember the break-even formula, the contribution margin, and the contribution margin ratio.
Earlier in the chapter, we discussed the contribution margin, contribution margin ratio and breakeven. These formulas are important in calculating the target sales volume or the selling price for each unit.
Formula for Calculating Target Income / Profits
The formula for calculating the total unit sales is:
Total unit sales = (Fixed costs &addition; Target Income) ÷ Contribution Margin per Unit
The formula for calculating the total dollar sales is:
Total dollar sales = (Fixed costs &addition; Target Income) ÷ Contribution Margin ratio
To better understand how to calculate the target income, it is important to use a relevant example.
Example of Target Income Problem - Scenario
Bilboards Inc. specializes in providing highway roadside advertisements spaces in the city of Fantabla. The company is charging its customers $100 for one advertisement per session. Billboards Inc. incurs variable costs of $18,000 a month, and fixed costs of $36,000 a month. If Billboards Inc. contracts and performs 600 advertisements per month, how many ads will it do a month to make a revenue of $20,000 in a month?Solution - Contribution Margin Approach
(Information given: variable costs = 18,000; fixed costs = 36,000; unit charge = 100; ads a month = 600; target income = $20,000)
Target Total Sales = (Fixed Costs + Target Income) / Contribution Margin Ratio
{Contribution Margin Ratio = Contribution Margin per Unit / Unit Sales Price = 100 − 30 = 70}
= (36,000 + 20,000) / 70
= 56,000 / 70
= 800 ads a month