Essay: Achieving the pretax profit target

9 Apr

Essay: Achieving the pretax profit target

Sample Essay

Every forecasted function or a model has its own limitations. At the same time, there is a great strength in the projections made for future goals. For instance, if we take sales forecast what special characteristics can a firm built to achieve their sales target? It can maximize production, get flexible on operating leverage or it can go for product development i.e. product mix. Table below shows the key strength and weakness of this model:

Sales Target

$ Millions

Targeted after-tax Profit

1500

Targeted Pretax Profit

2000

Contribution Margin Ratio

50%

CVP for Revenues (Sales)

7000

To achieve the pretax profit target of $2000 millions we need to have sales of $7000 millions. To meet the target, contribution margin ratio should be kept at minimum so that the divider of ‘cost volume profit for revenues’ is lesser which can increase revenues to a considerable level. Now, how can we reduce the contribution margin ratio to get our target profit? Sales should be increased to meet the target in such a case. If the organization has a capability to increase its sales given the required level of resources and capital this target can easily be achieved. At times, it is hardly possible for a firm to increase its sales specially under bad economic conditions, where macroeconomic factors make business vulnerable towards financial adversity. This can be a real problem for even a stable firm to cope up with its sales targets. For instance, if projected costs increase due to high prices of raw materials can a firm control its variable costs to meet the sales target? No, it cannot. Because sales are based on forecast, firms do whatever it takes to maintain their desired level of production so that targets are met and profitability is increased. To see this relationship, the following cost projection table can explain the effect of cost on sales:

Cost Projection

$ Millions

Forecasted Revenue

8000

Forecasted Pretax profit

2000

Forecasted Total Cost

5500

Actual Cost

6000

Increase in Actual Cost

500

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