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

What's in Here

In this lesson, we will learn how to calculate the number of units to sell in order to generate a desired level of profit. This can be achieved by tweaking the break-even formula and incorporating the desired profit.

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:

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 |

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.

More on Cost-Volume-Profit (CVP) Analysis

- 1Assumptions in CVP Analysis
- 2Contribution Margin
- 3Break-Even Point Analysis
- 4Target Profit (Desired Income)
- 5Margin of Safety
- 6Degree of Operating Leverage
- 7Multi-Product Break-Even Analysis
- 8Variable and Absorption Costing

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