Target net income
/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.
Loan Agreements
A lender may mandate that a borrower attain a certain minimum income level for as long as a loan is outstanding, or else the lender has the right to call the loan.
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Derivation of Target Income
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.
Problems with Target Income
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.