Cost Volume Profit Analysis (CVP): Target Profit

- [Instructor] 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,

and 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 talking 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 break-even.

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 of 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.

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 this $2.

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

I'm just gonna run out
of 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,

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.

I'm just gonna.

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
2, we divide it by the 5,

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.