How to Determine Target Profit with Contribution Margin Analysis
If you have set a specific goal for net income, contribution margin analysis can help you figure out the needed sales. This goal for net income is called target profit.
To compute target profit, just adapt one of the three net income formulas. Then simply plug target profit into one of these formulas as net income.
For example, say a company is pushing to earn $20,000 in profit and has to pay $10,000 in fixed costs. How much total contribution margin does the company need to generate in order to make its target profit of $20,000?
Net income = Total contribution margin – Fixed costs
$20,000 = Total contribution marginTarget – $10,000
$30,000 = Total contribution marginTarget
Total contribution margin of $30,000 will result in $20,000 worth of net income.
Now suppose a company has set its target profit for $2,000, earns contribution margin per unit of $5, and incurs fixed costs of $500. How many units must the company sell?
If the company wants to earn $2,000 in profit, it needs to sell 500 units.
Consider another company with a contribution margin ratio of 40 percent and fixed costs of $1,000. The company is looking to earn $600 in net income. How much does that company need in sales?
Don’t confuse dollars with units. The formula that uses contribution margin per unit gives you sales in units. However, the formula that uses contribution margin ratio gives you sales in dollars. To translate between these units, just multiply or divide by the sales price.