Deriving a Target Cost

NotesQuizObjective Test

Target Costing

A target cost is what's left over after you've subtracted your desired profit from your competitive selling price.

A product of acceptable quality is then designed within that cost.

Therefore, the main focus of target costing is not finding what a new product does cost but what it needs to cost.

The target cost setting process.

Steps In Target Costing

  1. Choose an appropriate Selling Price

    Looking at competitors prices / products

  2. Choose a desired Profit Margin

  3. This leaves the Cost Target

  4. Calculate the Cost Gap

    This is the Current costs - Target costs

    This gap would have to be closed, by some form of cost reduction (for e.g. value engineering), while satisfying the needs of customers.

Illustration
Targeted selling price 20
Gross profit margin Required
20%
Solution
Selling Price 20
Less: Profit Margin (4) (20% x 20)
Target Cost 16
NotesQuizObjective Test