Target Costing: Definition, Formula, What It Is, Examples, Approach, Calculation

Pricing and costing have always been important factors in a business’s success. To ensure the prices are competitive, yet still provide enough margin to generate profit, many companies turn to target costing.

Target costing is a management technique that involves setting prices based on market conditions. It helps businesses provide competitive prices while controlling costs and achieving a desired profit margin.

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Table of Contents

What is Target Costing?

Target costing is a cost management tool that helps businesses determine prices based on predetermined costs and pricing objectives. It focuses on the total cost of a product or service, taking into account all components and processes involved in its production.

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The goal of target costing is to design and manufacture products at predetermined costs, taking into account factors such as

Homogeneous products
Level of competition
Switching costs for the end customer

By setting predetermined costs, management has better control over their margin of profits and can stay competitive in the market.

Target costing is a great tool for managing prices – as it helps businesses determine prices that are attractive to customers, while still ensuring a good profit margin.

How to Calculate Target Costing

The formula for calculating target costing is relatively straightforward

Target Cost = Desired Selling Price – Desired Profit Margin

The desired selling price should be based on market conditions and competitive prices, while the desired profit margin depends on factors such as expected sales volume, overhead costs, and other business factors.

Once these two numbers have been determined, you can calculate the target cost of production.

By using this method, businesses can accurately determine prices and costs, ensuring they can stay competitive in the market while still maintaining a healthy profit margin.

The Importance of Target Costing

Here are some of the key benefits of target costing:

Allows Businesses to Remain Competitive

One of the main advantages of target costing is that it helps businesses remain competitive in the market. By accurately determining prices, businesses can ensure they are competitive while still maintaining a healthy profit margin.

Helps Control Costs and Manage Margins

Target costing also allows companies to better control their costs and manage their margins, by setting predetermined costs for production. It not only helps businesses remain competitive but also ensures they can maintain a healthy profit margin.

Promotes Innovation

Target costing encourages innovation and creativity in product design, as it requires companies to think of ways to reduce production costs while still maintaining desired levels of quality.

Companies can use new materials or processes that may be more cost-efficient, without having to sacrifice product quality.

Better Pricing for Customers

Finally, target costing helps businesses offer better prices to their customers. By accurately predicting costs and setting prices based on market conditions, companies can ensure their customers are getting the best value for their money.

It will increase sales as well as customer loyalty, as customers will recognize the company’s commitment to providing quality products at reasonable prices.

Conclusion

In conclusion, target costing is a powerful tool that can help businesses remain competitive while still managing their costs and achieving desired margins of profit. By accurately calculating prices and costs, companies can ensure they can stay competitive in the market while also maintaining a healthy margin of profit.