Cost Volume Profit Analysis (CVP): Target Profit

- In this video, I'm gonna
talk about how we can use

cost, volume, profit analysis in order

to reach a target net income
or a target profit level.

And what I mean by that is this.

So in a previous video we
talked about calculating

a break even point.

So let's put it here, just break even.

But the thing is, so let's
say you start this business

that we talked about, you
start a sub shop and you go

and you calculate this break even point

and you end up breaking even.

And then you tell your spouse,
hey, great, we broke even.

Well, they're gonna be upset because they

wanted to make money.

That's why you started this business.

You want to sell these subs.

You love subs, but also
you want to make money.

So we don't wanna just break even,

although that's a useful
thing to calculate,

just to kind of see as like a floor

of how many sandwiches do we have

to sell in order to break
even and not lose money.

But we also started this
business to make money,

to have a net income, to have a profit.

So we might say, when we
start out the business

and say, okay, well how
much money do we make?

Maybe we want a target profit,

or I'll just call it target net income.

Net income profit. We're
talking about the same thing.

But let's say the target net income,

NI, let's say that's $50,000.

Let's say that you wanna
make $50,000 a year

with your sandwich shop.

Now I'm not talking about
sales, I'm talking about profit

after we've done our
revenue minus our costs

and what's left at the
end, the bottom line.

So you wanna make $50,000
as the owner of this shop,

but you need to know how many sandwiches

do I have to sell in
order to make $50,000?

Well, just like the break even point,

we need to know certain things.

And I've already taken the
liberty of writing 'em down here.

We need to know price, the variable costs,

contribution margin,

which is calculated from
those two and the fixed costs.

Okay, so price, we're
assuming that we sell

each sandwich for $5,

and then we're assuming
that the variable cost

associated with each sandwich,
the lettuce, the pickles,

the bread is $3.

And that difference there
is our contribution margin.

So every sub we sell $2 is
contributed toward fixed costs

or as we're gonna find in this example,

that target profit figure that we want.

So how do we go ahead and calculate this?

Well, let's say first
that we want to find it,

let's say we want target net income.

We wanna know how many units.

By units we're talking about,

how many sub sandwiches do we have

to sell in order to get this?

So we use a formula that's very similar

to the one we use for the breakeven.

So what we're gonna have is
we're gonna have our fixed costs

on top in the numerator,

but also this time we're
gonna have something else,

we're gonna add in that target net income.

So I'm just gonna call it NI there.

So that's the profit that we want.

So the fixed cost of 20,000

plus the profit that we want a 50,000.

So let's fill in the denominator here.

So here we're gonna have the
contribution margin per unit,

and that's just that $2 figure.

And that part is no different than when we

calculate the break even.

So when we put this together,

we've got 20,000 of fixed costs

plus 50,000, that's our target profit.

So now we not only have to
cover those fixed costs,

that rent and all those
things that don't vary

with the amount of subs we sell.

We not only have to cover that with

this contribution margin that
we earn on each sandwich,

but we also have to cover
this profit that we want.

Okay and then the contribution margin

for our units over here is $2.

Okay so that's gonna give
us 35,000 units here.

I'm just gonna run
outta space a bit there.

So we'll say 35,000 units
or 35,000 sub sandwiches.

That's how many sandwiches we have to sell

assuming these things here

that we sell $5 a sub,
and these are our costs.

If we sell 35,000 sandwiches,
we can cover these fixed costs

and earn ourselves this
$50,000 that we wanted.

So now just like the break even analysis,

we can also say, well, I
don't wanna just look at it in

terms of units,

in terms of how many sub
sandwiches I have to sell.

Maybe I wanna look at it in
terms of what is my sales,

my bottom, or at the end of the year

when I run up the
register, how many times,

what is the sales, what is the total sales

that I had for the year
or the month or whatever

in order to get that target
net income of $50,000.

So we're gonna calculate that.

And that's also very similar

to the break even point calculation.

So the target net income, again here,

we want $50,000 profit again,

but this time we want to know what has

to be the total sales.

So, the numerator is gonna be the same,

fixed costs plus our target net income.

But this time at the bottom,

similar to the break even analysis,

we're gonna have our
contribution margin ratio.

What is the contribution
margin ratio again?

Well, we're basically trying to calculate

how many cents of every dollar
becomes contribution margin

whenever we have a sale.

So what we do, we take this
two, we divide it by the five,

and that's gonna give us 0.4,

that's our contribution margin ratio.

40 cents of every dollar

of sales becomes contribution margin.

It can be contributed
toward our fixed costs

and that target profit
that we have up here.

So we're gonna have, again, 20,000

plus 50,000,

only this time the numerator,

or excuse me, the denominator is gonna be

that contribution margin ratio of 0.4.

And we are going to have

sales of $175,000.

So now if you look at these two things,

they're not equivalent,

but they're basically
stating the same thing

because 35,000 subs, 35,000 units,

we say, okay, well we
sell them at $5 a sub.

Well that's gonna give us $175,000.

So it's basically two ways
of expressing the same thing.

If we have $175,000 in sales,
given these assumptions here,

we'll end up making a profit of $50,000.