Setting targets for costs according to market conditions Show What is Target Costing?Target costing is not just a method of costing, but rather a management technique wherein prices are determined by market conditions, taking into account several factors, such as homogeneous products, level of competition, no/low switching costs for the end customer, etc. When these factors come into the picture, management wants to control the costs, as they have little or no control over the selling price. CIMA defines target cost as “a product cost estimate derived from a competitive market price.” Target Costing = Selling Price – Profit MarginWhy Target Costing?In industries such as FMCG (Fast Moving Consumer Goods), construction, healthcare, and energy, competition is so intense that prices are determined by supply and demand in the market. Producers can’t effectively control selling prices. They can only control, to some extent, their costs, so management’s focus is on influencing every component of product, service, or operational costs. The key objective of target costing is to enable management to use proactive cost planning, cost management, and cost reduction practices where costs are planned and calculated early in the design and development cycle, rather than during the later stages of product development and production. Key Features of Target Costing:
Advantages of Target Costing
ExampleABC Inc. is a big FMCG player that operates in a very competitive market. It sells packaged food to end customers. ABC can only charge $20 per unit. If the company’s intended profit margin is 10% on the selling price, calculate the target cost per unit. SolutionTarget Profit Margin = 10% of 20 = $2 per unit Target Cost = Selling Price – Profit Margin ($20 – $2) Target Cost = $18 per unit Download the Free TemplateEnter your name and email in the form below and download the free template now! Target Costing TemplateDownload the free Excel template now to advance your finance knowledge! Related ReadingThank you for reading CFI’s guide to Target Costing. If you’re interested in advancing your career in corporate finance, these CFI articles will help you on your way:
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