Target costing

Target costing refers to developing/manufacturing the specific product, keeping cost under a set threshold. This mechanism of production keeping cost under set boundaries /limits is called Target costing.

It helps ensure the product is developed under the desired/target cost.

It’s a smart costing technique that starts with market research and involves following steps.

Steps of target costing

1. Conduct market research to estimate the selling price.
2. Set up the desired profit margin expected from selling the product.
3. Deduct the desired profit margin from the expected selling price.

This type of costing technique is suitable for companies adopting a no-frill or low-cost model. These companies target price-sensitive customers willing to compromise on product features but can’t afford to pay a higher price.

The best part of this costing approach is conducting market research that is focused on selling the product, which is a prime requirement to ensure business success.

Target costing formula

Target cost = estimated selling price – desired profit

Example of target costing

Consider that the selling price for product A is $40 in the market, and the business desires to make $5 by selling this product. In this case, we can apply the formula as given.

Target cost = Estimated selling price – desired profit

Target cost = $40 – $5

Target cost = $35

Interpretation

To earn a $5 profit, the business needs to manufacture the product for $35. By analyzing product development cost, the business can ascertain if they can develop product for $35.

Wrap up

Target costing involves manufacturing the product while keeping the cost threshold. Adopting this costing method helps ensure the business will be able to reach its desired profitability.

Target cost is calculated by deducting the desired profit from the product’s selling price.