Target costing - part 2

In this lesson

1. 0:00 Target Costing example introduction
2. 1:49 Understanding profit mark-up concept
3. 2:29 Calculating target profit and cost
4. 4:11 Working out the cost gap
5. 4:48 Summary and correct answer

About this lesson

You'll discover how to calculate three critical figures: the target profit, the target cost, and the cost gap—and why understanding the relationship between these elements is essential for determining whether a product is financially viable. The key to target costing is understanding profit markup: profit expressed as a percentage of cost. We'll show you how to set up a simple percentage structure that reveals the relationship between selling price, target profit, and target cost. Once you grasp this framework, you can work backwards from a known selling price to find the other figures. In this example, a $200 selling price with a 25% markup gives you a target profit of $40 and a target cost of $160 per unit. The final step is calculating the cost gap—the difference between your estimated production cost and your target cost. Here, the estimated cost is $170 but the target is $160, leaving a $10 gap you'd need to close through design changes or process improvements. This technique is essential for Performance Management and Strategic Business Leader papers, where you'll need to assess product viability and make recommendations on cost reduction strategies.

Duration: 5m