# Target Income Analysis

Target income analysis is a management accounting technique used to identify a company’s target income sales, the sales level that must be achieved to earn a target net income.

Target income sales depends on a company's fixed costs, target operating income and contribution margin per unit and/or contribution margin ratio. The target operating income in turn depends on the target net income and applicable tax rate.

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

We start with a target net income and use it to work back to the sales level. First, we need to work out the target operating income which is effectively the income before taxes:

$$\text{Target Net Income}\ =\ \text{Target Operating Income}\ \times(\text{1}\ -\ \text{Tax Rate})$$

A bit of rearrangement gives us the formula for target operating income:

$$\text{Target Operating Income}\ =\ \frac{\text{Target Net Income}}{\text{1}\ -\ \text{Tax Rate}}$$

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

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

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

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

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

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

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

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

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

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

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

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

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. If the company's tax rate is 30%, determine how many liters the company should be able to sell and the amount of total sales. Solution Target operating income =$150,000 ÷ (1 − 30%)
= $214,286 Contribution margin per unit =$10 − $2 −$1
= $7 Contribution margin ratio =$7 ÷ $10 = 70% Target income sales in units = ($200,000 + $300,000 +$214,286) ÷ $7 = 102,041 units Target income sales in dollars = ($200,000 + $300,000 +$214,286) ÷ 70%
= $1,020,410 Target income sales can also be determined as product of per unit sales revenue and target income sales in units i.e. ($10 × 102,041 = \$1,020,410).