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Target Net Income: Definition & Formula

Target Net Income: Definition & Formula
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  • 0:03 What Is Target Net Income?
  • 0:39 Formula
  • 1:11 Using the Formula
  • 3:03 Contribution Margin
  • 3:53 Cost-Volume-Profit Graph
  • 4:57 Lesson Summary
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Lesson Transcript
Instructor: Yuanxin (Amy) Yang Alcocer

Amy has a master's degree in secondary education and has taught math at a public charter high school.

Watch this video to learn how a business figures out its target net income. We'll learn the formula as well as explore contribution margin and cost-volume-profit graphs.

What Is Target Net Income?

Meet Greg. He's the owner of a cupcake shop. His specialty is that his cupcakes are miniature versions of bigger cakes. They're fully decorated and look so yummy and cute! This weekend he's participating in an arts and crafts fair as one of the food vendors. He needs to know how many cupcakes he needs to sell in order to make it worthwhile for him to be at this show. He has a goal of how much he needs to make. This goal is called his target net income - the total income he needs to get. How can he figure out how many cupcakes he needs to sell in order to meet his target net income for the event?

Formula

Greg just happens to have a friend who is pretty good at math. Greg asks him for help and his friend directs him to the formula for target net income.

Target Net Income = Sales - Variable Costs - Fixed Costs

His friend explains that this formula tells you that the target net income is calculated by subtracting your costs from your sales. To figure out how many cupcakes Greg needs to sell, he'll be using a variable with the sales and the variable costs parts of the formula and then solving for it.

Using the Formula

Greg takes this information in, and then he goes back into his office to do the calculation.

He's selling his cupcakes for $7 each with a target net income of $1000. In other words, the sales part of his formula will be $7 times the number of cupcakes sold. His formula now looks like this:

$1000 = ($7 * number of cupcakes sold) - Variable Costs - Fixed Costs

The variable costs are expenses that change with the amount produced, like the amount of ingredients Greg will use to make cupcakes. The more cupcakes Greg needs to bake, the more ingredients he needs to buy. Graphed out, your variable costs will be a diagonal line. For Greg, his variable cost per cupcake is $2.00. In the formula, the variable cost will be multiplied by the number of items sold.

Fixed Costs, on the other hand, are expenses that don't change, such as Greg's vendor fee. Calculating these, Greg writes down his variable costs as $2.00n and his fixed costs as $250. Plugging these into the formula and then substituting in n for the number of cupcakes sold, his formula now looks like this:

$1000 = $7n - $2n - $250

Solving for n, Greg gets this:

$1000 = $5n - $250
$1000 + $250 = $5n
$1,250 = $5n
$1,250 / $5 = $5n / $5
250 = n

Ahh! Greg needs to sell 250 cupcakes to meet his target net income of $1000 for the event.

Contribution Margin

If you didn't have a target net income but wanted to figure out your net income, you can use the same formula by replacing your target net income with net income:

Net Income = Sales - Variable Costs - Fixed Costs

Your sales minus your variable costs is also referred to as your contribution margin. Sometimes you are given this instead of your sales numbers. You can think of your contribution margin as the amount from sales that are left to cover fixed costs.

Net Income = Contribution Margin - Fixed Costs

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