Essay: Achieving the pretax profit target

Essay: Achieving the pretax profit target

Every forecasted function or model has its own limitations. At the same time, there is 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 its sales target? It can maximize production, get flexible on operating leverage or it can go for product development i.e. product mix. The table below shows the key strength and weakness of this model:

To achieve the pretax profit target of $2000 million we need to have sales of $7000 million. To meet the target, the contribution margin ratio should be kept at a 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 the 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 especially under bad economic conditions, where macroeconomic factors make the business vulnerable to 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 the 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:

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