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What is target costing?

Target costing is a system in which a company plans in advance the price points, product costs, and margins that it would like to use to achieve a new product. This concept will use the selling price of the product in order to determine the production of the cost that is required to enter the market.

Target Costing Example:

Below is an example calculation for target costing. As you can see, the company would base the selling price of a new product on existing factors in the market. Additionally, they would have to factor in a desired profit on each unit, otherwise, what is the point of selling the product, right?

In our example, Sun Surf analyzes the market and determines the new surfboard will have a selling price of $450. Since they require a profit margin of 30%, that means that $135 of the $450 selling price will have to result in a profit. We’re left with a target cost of $315, which means that the company must be able to produce and sell the product for $315 per unit or less.

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