Target Income Sales

In cost-volume-profit analysis, target income sales is the level of sales that must be achieved to earn a target income. It is calculated by dividing the sum of fixed costs and target income by the contribution margin ratio.

Calculating target income sales is an important part of the cost-volume-profit analysis. Every business must earn enough revenue not only to cover its variable and fixed costs, but to be able to generate a decent return on its investment. It is useful to have a number in mind when preparing a sales budget or assigning sales targets.

Formula

Target income sales in units can be worked out by dividing the sum of total fixed costs and target income by the contribution margin per unit:

$$ Target\ Income\ Sales\ (in\ Units)\\=\frac{Fixed\ Costs\ +\ Target\ Income}{Contribution\ Margin\ per\ Unit} $$

Contribution margin per unit equals contribution margin (excess of revenue over variable costs) divided by total output i.e.

$$ Contribution\ Margin\ per\ Unit\\=\frac{Sales\ -\ Variable\ Costs}{Total\ Units\ Sold} $$

Target income sales in units can be converted to target income sales in dollars by multiplying it with price per unit.

$$ Target\ Income\ Sales\ in\ Dollars\ \\=Target\ Income\ Sales\ in\ Units\times Price\ per\ Unit $$

Alternatively, we can use the following formula to calculate target income sales in dollars:

$$ Target\ Income\ Sales\ (in\ Dollars)\\=\frac{Fixed\ Costs\ +\ Target\ Income}{Contribution\ Margin\ Ratio} $$

Contribution margin ratio equals the difference between sales and variable costs divided by sales.

$$ Contribution\ Margin\ Ratio\\=\frac{Sales\ -\ Variable\ Costs}{Sales} $$

Contribution margin ratio can also be calculated by dividing contribution margin per unit by price:

$$ Contribution\ Margin\ Ratio\\=\frac{CM\ per\ Unit}{Price}=\frac{Price\ -\ Variable\ Cost\ per\ Unit}{Price} $$

Contribution margin ratio also equals 1 minus variable cost ratio.

Example

Orange Juices Inc. is a company engaged in packaging and distribution of fresh orange juices. Its revenue per liter of juice is $10. Its manufacturing costs are as follows:

Costs of raw oranges used per liter $2
Direct labor costs per unit 1
Fixed manufacturing overheads 200,000
Fixed administrative and distribution costs 300,000

The company wants to generate net income of $150,000 at least. Determine how many liters the company should be able to sell and the amount of total sales.

Solution

Contribution margin per unit = $10 − $2 − $1 = $7

Contribution margin ratio = $7 ÷ $10 = 70%

Target income sales in units = ($200,000 + $300,000 + $150,000) ÷ $7 = 92,857

Target income sales in dollars = ($200,000 + $300,000 + $150,000) ÷ 70% = $928,571

Target income sales can also be determined as product of per unit sales revenue and target income sales in units i.e. ($10 × 92,857 = $928,571).

Written by Obaidullah Jan, ACA, CFA and last revised on