Question

Under what circumstances would you use target profit analysis? Why?

Answer 1

Target profit analysis means analysing the required amount of sales to be reached by the organization or the estimation of certain performance to be reached by production department for achieving the targeted  profit.

General methods used in Target Profit Analysis to compute the targeted output or units to be produced are as follows:-

a) Equation method

b) Contribution method

Under equation method,Sales required = Fixed cost + Variable cost + Targeted profit

Under Contribution method, Sales required =(Fixed costs + targeted profit) / Profit volume ratio

Circumstances under which Target Profit Analysis is used are as follows:-

1) To know the amount of sales required to earn back the fixed expenses.

2) To reach the targeted profit required by the organization

3) When there is a change in target of profit, the amount of units to be sold have to be calculated

4)At the same time any change in Fixed or Variable expenses which effects the number of units to be sold to get targeted profit.

A brief explanation about why Target profit analysis should be used in above given circumstances:-

To know the amount of sales required to earn back the fixed expenses:- It is very important to know the amount of sales or number of units to be sold inorder to get the fixed costs back. Because fixed costs are uncontrollable and inevitable costs we have to pay those costs and we should get minimum amount of income to pay back those fixed expenses.

To reach the targeted profit required by the organization:- Every organization will have some target regarding the amount of profit that has to achieve. So, to know the amount of sales or number of units to be sold to achieve that targeted profit, Target Profit Analysis is used.

When there is a change in target of profit:- In case of increase or decrease in amount of profit required to achieve by the organization or any department then, Targeted Profit Analysis is used to know the amount of Targeted units to be sold to achieve the targeted profit.

Change in Fixed or Variable expenses:- If there is any changes in amount of Fixed or variable cost incurred by the organization or any functional department of the organization, the change will have direct impact on the total cost of the production and at the same time effects the number of units to be sold, because even though there will be no change in Targeted profit,  the number of units to be sold will change with change in Fixed and variable expenses.