A target profit can be built into the equation as if it were an additional fixed cost. At the break-even point, operating income is zero, which is rarely the goal of a for-profit company. An owner or manager may identify a desired operating income and add that amount to the fixed costs in the numerator. The question then becomes: How many units does the company have to sell to pay all its expenses for the month AND earn a profit of $X? The resulting number of sales units will generate this desired operating income.

Let’s define two terms:

• Operating income (from the contribution margin statement)
• Profit (using it’s generally accepted definition)

Operating Income

Operating income for a business like The Home Depot, Inc. would be the difference between sales of home improvement goods and services, like lumber, appliances, tiles, etc., and the ordinary expenses related to those sales, such as rent on stores and warehouses, inventory, and wages.

If you compared operating income between two similar companies, such as Lowes, Inc. and The Home Depot, Inc., you would be comparing apples to apples.

Profit

Profit is often used in a variety of ways. For instance, in CVP analysis, it is often used as a synonym for operating income. However, it also sometimes means “net income” which could include non-operating expenses, such as interest on debt.

Interest on debt is not usually included in financial account net income because one company may rely heavily on debt financing that incurs interest expense, and another similar company may rely more heavily on owners contributing capital (money) to the organization. Another common non-operating item is gain or loss on the sale of assets.

In this module, we’ll use the terms profit and operating income interchangeably, but beware that these terms may have different meanings depending on the context.

Target Profit

Let’s run our analysis again, this time adding in a target profit of $850 per month.

We know each unit provides $1.70 in contribution margin. The contribution margin covers fixed costs and profit.

In this case, we want to know the point where profit is closest to $850, which means we have to cover fixed costs of $3,400 AND the profit of $850 (3,400 + 850 = 4,250).

Divide fixed costs plus profit by contribution margin per unit:

(850 + 3,400) / 1.70 = 2,500 units.

We can enter that into our Contribution Margin statement to see if it works:

Again, as with break-even, we could calculate the target profit point by dividing fixed costs plus profit by the contribution margin ratio, which will give us the target profit point in sales dollars:

$4,250 / 0.17 = $25,000.00

Since each unit sells for $10.00, the number of units we need to sell to achieve the target profit would be:

Total sales / price per unit = total units

$25,000 / $10 = 2,500 units

Here is a review of calculating a target profit:

You can view the transcript for “Cost Volume Profit Analysis (CVP): Target Profit” here (opens in new window).

Now, let’s check your understanding of calculating the target profit point.