CMA Final · Strategic Cost Management

Target Costing: formula sheet

Full chapter guide

Key formulas

Target cost: Target Cost = Target Selling Price − Target Profit; Price comes from the market. Cost is the balancing figure.
Target profit on sales: Target Profit = Target Selling Price × Required profit margin %; If the profit is given as a markup on cost, convert it to a margin on selling price first. A 25% markup on cost equals 20% on selling price.
Target profit on investment: Target Profit = Capital employed × Required return %; Divide by the number of units to get profit per unit.
Cost gap: Cost Gap = Estimated Current Cost − Target Cost; A positive gap means cost must be reduced. Zero or negative means the target is met.
Cost-plus price: Selling Price = Cost + Markup; Traditional approach. Target costing uses Cost = Price − Profit.
Target cost: Target cost = Target selling price − Target profit; Target profit may be given as an amount or as a percentage of selling price or of cost. Read which.
Cost gap (cost reduction required): Cost gap = Expected (current) cost − Target cost; A positive gap means cost must be reduced. The team must close it through design changes.
Target profit on sales: Target profit = Selling price × Required margin %; If margin is on cost, profit = Cost × margin %, and selling price = Cost × (1 + margin %).
Target profit (on sales): Target profit = Target selling price × Desired profit % on sales; Use this when the margin is given as a percentage of selling price.
Allowable cost: Allowable cost = Target selling price − Target profit; Also equals Target price × (1 − margin % on sales).
Target price from cost plus mark-up (check): Price = Cost × (1 + mark-up %); Only for converting a mark-up on cost into a margin on sales. Mark-up m on cost equals margin m ÷ (1 + m) on sales.
Cost gap: Cost gap = Drifting (current) cost − Allowable (or target) cost; Positive means the cost must be reduced. State which benchmark you used.
Target profit from ROI: Target profit = Capital employed × Required return %; Divide by units to get profit per unit. Use the same period for profit and units.
Gap as a percentage: Gap % = Cost gap ÷ Drifting cost × 100; Shows how much of the current cost must be cut.
Target cost: Target cost = Target selling price − Target profit; Target profit may be given as a margin on price or on cost. Read the base carefully.
Cost gap (cost reduction required): Cost gap = Estimated (current) cost − Target cost; This is the amount VE and other methods must remove per unit or in total.
Value index: Value index = Function's share of customer value (%) ÷ Function's share of cost (%); Below 1 means over-costed, so look for savings. Above 1 means under-costed relative to its value. Near 1 is balanced.
Target cost of a function: Function target cost = Function's value weight × Overall target cost; Compare with the function's current cost to find the reduction needed for that function.
Value (concept): Value = Function (benefit to customer) ÷ Cost; VE raises value by keeping function and lowering cost, or by raising function at the same cost.
Target cost: Target cost = Target selling price − Target profit; Target profit may be given as an amount or as a % of selling price or of cost. Read the base carefully.
Cost gap: Cost gap = Estimated current cost − Target cost; A positive gap must be closed by value engineering, supplier negotiation or process change.
Kaizen cost target: Kaizen target cost for the year = Previous year's actual cost × (1 − kaizen reduction %); Applied to the cost base of the existing product. Check whether the % applies to total cost or to a single cost item.
Life-cycle cost: Life-cycle cost = Upstream cost (R&D, design) + Manufacturing and distribution cost + Downstream cost (service, warranty, disposal); Per-unit life-cycle cost = Total life-cycle cost ÷ Total units over the life.
Target life-cycle profit check: Life-cycle profit = Total life-cycle revenue − Total life-cycle cost; The product is viable only if this meets the required profit over the whole life, not just in one year.

Quick revision

Target costing works backward from market price, not forward from cost.
Target Cost = Target Selling Price − Target Profit.
Cost Gap = Current Estimated Cost − Target Cost; a positive gap means cost must come down.
If profit is a percentage of sales, take it off the price. If it is a percentage of cost, divide the price by (1 + percentage).
Cost is designed in at the planning and design stage, where most of it gets locked in.
Cross-functional teams of design, production, marketing and finance work on the target together.
Value engineering reviews design and function before production to remove cost the customer does not value.
Value analysis does the same review for existing products.
Kaizen costing delivers small, continuous cost cuts during the production stage.
Life-cycle costing tracks cost from design to disposal, so savings in one stage should not raise cost in another.
Always end a numerical answer with a clear recommendation.

Common mistakes

Adding a markup to cost to find the price. Fix: Start from the price. In target costing, cost is derived: Price − Profit.
Treating a markup on cost as a margin on sales. Fix: Read the base. If it is on cost, convert: 25% on cost is 25 ÷ 125 = 20% of selling price.
Describing target costing as cost plus profit equals price. Fix: Always write the direction: price first, then subtract profit to reach the cost.
Saying cost reduction happens mainly during production. Fix: State that target costing focuses on design. Savings after launch are limited because most cost is already committed.
Treating a margin on cost as a margin on sales Fix: Read the base. If it is on cost, price = cost × 1.20. If it is on sales, allowable cost = price × 0.80. Convert if the question mixes the two.
Subtracting in the wrong direction for the cost gap Fix: Always write drifting cost first. A positive answer means cost must fall.
Treating value engineering and value analysis as the same thing. Fix: Say that VE applies before production at design stage and VA applies to products already in production. Link VE to target costing.
Calculating the target cost wrongly when profit is stated as a percentage of cost. Fix: If profit is x% on cost, cost = price ÷ (1 + x). If it is x% on price, cost = price × (1 − x).
Calculating profit as a % of cost when the question gives it as a % of selling price. Fix: Underline the base word (on sales / on cost). If on sales, target cost = price × (1 − profit %). If on cost, target cost = price ÷ (1 + profit %).
Treating kaizen costing as the same as target costing. Fix: Remember the stage. Target costing is before launch and starts from price. Kaizen is after launch and starts from last year's actual cost.

Exam tips

In a numerical, show the three lines separately: target price, target profit, target cost. Marks are given for each line.
Check whether profit is on cost or on sales before computing anything. Examiners often set this trap.
When asked to compare with cost-plus pricing, write the direction of logic for each: cost-plus is cost → price, target costing is price → cost.
End every case answer with a recommendation and one or two practical cost-reduction actions.
In MCQs, remember target cost is a ceiling set before launch, not a historical cost.
Open any theory answer with the formula: target cost = price − profit. It shows the direction at once.
For advantages and limitations questions, give a balanced list with at least two points on each side.
In case questions, name the cross-functional team members and customer features from the scenario.