Target costing
In one sentenceA method that starts from the selling price the market accepts and subtracts the required profit to set the maximum cost allowed for the product.
Simply put
Instead of calculating the cost and then adding a profit, you start from the market: what price will the customer pay? Then you subtract the profit you want, and what remains is the target cost.
If the expected cost is higher, you must reduce it by changing materials, design or supplier before production, not after.
Worked example
A furniture factory wants to launch an office chair; the suitable market price is 200 SAR, management wants a profit of 25% of the selling price, and the currently expected cost is 165 SAR.
Selling price accepted by the market200 SAR
Required profit200 × 25% = 50 SAR
Target cost200 − 50 = 150 SAR
Gap that must be cut165 − 150 = 15 SAR per unit
Formula: Target selling price − required profit
Don't confuse it with
Cost-plus pricingCost-plus starts from the cost to reach the price, while target costing starts from the price to reach the cost.