Target Profit Formula

Published by Alex on

Have you ever wondered how businesses evaluate their profitability? Every business sets certain targets to achieve. Among these set targets is the amount of profit to make over a set period. Once the target is in place, it’s time to ensure the goal yields the expected fruits.

Many companies have a budget that comes about during the budget creation process. Within the budget is the target profit of each company plus other financial details. Stick around and get to understand why the target profit formula is so crucial to every business.

What Is a Profit Target?

Just as important as it is for an individual to have a plan in life, businesses have the same over a lifespan. The owners or managers set certain goals that the enterprise must achieve to thrive. Among these targets is profit.

Profit is crucial for the survival of any business. It can only survive with losses for a certain duration before it’s time to close the doors. Managers use the target profit formula to determine how much profit the company aims to make over a given period.

Still, it’s worth noting that a budget is a plan but not the actual outcome. It’s the income statement that proves whether the company achieved the set goals or not. There are too many inaccuracies in budgets to rely on it 100%.

It’s why companies have an alternative when it comes to foretelling the future. A company relies on a rolling forecast that requires a regular update of the target information. The goal is to take into account every change that takes place along the way.

The target profit is an estimate of what a company expects to make and not the actual amount. This gives you room to surpass the goal or even go lower depending on the business climate.

Method of Calculating Target Profit

Profits are the lifeline of every business. If a business makes continuous sales but still does not make any profit, that is a sign there’s a problem. The target profit formula can help you understand your expectations for the business over a set period.

To calculate the target profit, you require a revenue estimate plus expenses to achieve the target profit equation. It means you take:

Estimated total revenue-Estimated total expenses = Target profit

Here estimations are necessary since the actual sales and expenses haven’t taken place. Knowing how to calculate target profit can help you plan a future for your business. You have to estimate the timeframe in mind at the beginning before you can begin the calculation.

Companies tend to have quarterly or annual estimations of the total amount of revenue to make. One essential part of the budget in terms of expenses is fixed costs. These are costs like rent of the premises, insurance, and even labor.

Fixed costs plus variable costs give you the estimation of the total expenses over the given period.

Advantages of Using Target Profit Formula

Create Direction

There’s no need to start a journey without a destination in mind, right. The same applies to a business. It makes more sense to know where it’s heading from the beginning. Here is where the target profit formula comes into effect.

A company can use the formula for target profit to learn more about its destination. This makes it easier to set goals for the whole team, including those in the sales department. They know they have to sell a certain number of products or services to achieve their profit goals.

1. Increase Sales Prospects

In every sales department, there are always regular meetings about sales goals and targets. Using the profit target formula, a company can get to know how many products to sell to achieve a certain goal. This information trickles down to the sales department.

Here, the sales team must increase their prospects to meet the target profit. If not, then that sales period isn’t successful. Therefore, calculate the target profit then get to know the total sales necessary to achieve this amount.

2. Cost-cutting Measures

Target profit is a result of subtracting total cost from total revenue. One way of achieving the target profit or increasing it is by lowering total costs. These are all estimations, but they can be an eye-opener for every business.

There are two types of costs, namely fixed and variable. Fixed costs are more permanent and might not have room to budge. But, variable costs can always be lowered to increase a company’s profit over a certain period.

By learning the variable costs expected during this time, a business can implement cost-cutting measures. This lowers the total expenses and makes the business more likely to achieve the target profit.

3. Opens Line of Communication

Communication between departments in a business is essential for its survival. Using the target profit formula, a company can set off plenty of communication between departments.

Each department has a role to play in achieving the set amount but can’t achieve it independently.

Disadvantages of Using Target Profit Formula

Unrealistic Profit Goals

Some companies find it hard to use the target profit formula since this is an estimation. They’d rather make the sales than calculate the profit after the end of the set period. This is seen as more accurate information rather than relying on estimations.

1. Hampers Productivity

As wonderful as it is to have estimated in a business, this can also hamper productivity. When the sales team achieves the target profit, they won’t be too motivated to surpass it.

It’s better for there to be an infinite target profit margin formula that keeps them productive for the given period.

2. Set Extremely High Standards

Estimations are important when using the target profit formula. However, some managers can use this information to overwork salespeople. They give them extremely high targets to achieve, which affects productivity and leads to lower sales at the end of the given period.

3. Uncertain Fixed Costs

At times it’s easy to see fixed costs as permanent. But, that’s not always the case which contributes to the uncertainty of target profit. Fixed costs can change. For instance, an insurance company can adjust premiums for a business because of certain reasons.

In addition, the rent of a premise can go up or down even without prior notice from the landlord. This uncertainty of fixed costs affects the total costs on the budget and the resulting target profit.

Certain measures can be implemented to control fixed costs, but this might not work 100%.

Calculation Examples

Example 1

Profit = Total revenue – Total expenses

Let’s start with:

Target Revenue= $8000

Total Expense estimate= $5500

The target profit will be:

$8000 – $5500 = $2500

$2500 is the target profit.

Example 2

Profit = Total revenue – Total expenses

Let’s start with:

Target Revenue= $100000

Total Expense estimate= $65000

The target profit will be:

$100000 – $65000 = $35000

$35000 is the target profit

Example 3

Profit = Total revenue – Total expenses

Let’s start with:

Target Revenue= $80000

Total Expense estimate= $55000

The target profit will be:

$80000 – $55000 = $25000

$25000 is the target profit

Concluding Remarks

The target profit formula is quite essential when a company wants to plan its future. It shows how much it expects to make in terms of profits over a given period.

Company owners can use the target profit pricing formula to determine how much each product or service will cost the consumer to achieve target total revenue.

Still, target profit can be inaccurate since things change. The total revenue can be higher or lower than the estimate. The same goes for total costs, which are the sum of fixed and variable expenses. Even fixed expenses tend to change, which affects the budget of a company.

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