Target income is the profit that the managers of a company expect to attain for a designated accounting period. It is a key concept in a corporate control system that drives corrective management actions. The term is used in the following situations:
- Budgeting. Managers may structure the expenditures of a business to attain a certain target income. This requires advance planning for expenditure levels through a periodic budgeting process. The target income figure may be based on a variety of factors, such as a desired rate of return on capital, a necessary cash flow level, or a certain amount of earnings per share.
- Compensation planning. The human resources staff can use target income levels to set bonus goals for senior managers, or as the basis for a bonus pool for all employees.
- Investor relations. The investor relations officer or chief financial officer using ongoing guidance to keep the investment community appraised of the target income that a business expects. Investors then use this information, along with an array of other information about a business, to estimate what its stock price should be.
Target income can be derived with cost-volume-profit analysis, which uses the following calculation:
- Multiply the expected number of units to be sold by their expected contribution margin to arrive at the total contribution margin for the period.
- Subtract the total amount of expected fixed cost for the period.
- The result is the target income level.
Excessive reliance on the target income concept can have an adverse impact on a business, since managers may spend too much time twisting company results to attain the target income amount, and not enough time focusing on improving the operations of the business. Long-term improvements may temporarily result in declines in short-term target income, which are offset by long-term profitability.