What is target costing and how is it calculated?

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Author: Sarthak Bhalerao

Table of Contents

  1. What is Target costing?
  2. Why target Costing?
  3. Key features of Target costing
  4. Advantages of Target Costing
  5. Example

What is Target Costing?

Target costing is a method of costing and a management technique wherein the prices are determined depending upon the market conditions by considering several factors such as homogeneous products, level of competition, switching costs for the end customer, etc. The management feels the need to control the costs when these factors come into the picture.

Target Costing = Selling Price – Profit Margin

Why Target Costing?

The competition in construction, Fast-moving consumer goods (FMCG), healthcare, and energy is so intense that the prices are determined by the demand and supply in the market. The producers cannot control the selling prices of the products. The main focus of the management is influencing every component of product, service, or operational costs. The primary objective of target costing is to make sure that the management uses proactive cost planning, cost management, and cost reduction practices.

Key features of Target Costing

  • The market conditions determine the price of the products.
  • The target selling price includes the minimum required profit margin.
  • It is a management strategy to focus on cost reduction and effective cost management.
  • Built-in product designs, specifications and customer expectations.
  • Cost reduction
  •  

Advantages of Target Costing

  • Improves management’s commitment and product innovation to gain competitive advantages
  • Cost is based on customer expectations. This makes the customer feel more valuable.
  • Improvement is the operation of the company. This helps create economies of scale.
  • The approach to design and manufacturing becomes market-driven
  • New opportunities are converted into real savings to achieve the best value for money.

Example

Britannia is a big FMCG multinational company that operates in a very competitive market. It sells packaged food to their customers. Britannia can charge Rs. 50 per unit. If the company’s intended profit margin is 30% on the selling price, calculate the target cost price per unit.  

Solution:

Target profit margin = 30% of Rs. 50 = Rs. 15 per unit

Target Cost = Selling price – Profit margin = Rs. 50 – Rs. 15

Target cost = Rs. 35

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