Target Costing- A Tool for Effective Profit Planning

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REVIEW OF RESEARCH PAPER

“TARGET COSTING- A TOOL FOR EFFECTIVE PROFIT PLANNING”


CITATION

Title of Research Paper: Target Costing- A Tool for Effective Profit Planning

Objective of the study:

To study the importance and usefulness of target costing in effective planning of profits in a competitive market.

Research problem:

The impact of target costing on planning of profits.

Methodology:

Type of data:

The type of data collected is primary data. The data was collected by conducting surveys in various manufacturing companies.

Sampling Procedure:

  • Sampling Size:

The researcher has chosen a sample of fifty six manufacturing companies for the study. These companies represent various sectors such as pharmaceuticals, FMCG, Automoblies and so on.

  • Sampling Technique:

The kind of sampling used is convenience sampling. The reason being that the researcher has chosen the manufacturing companies for the survey as per his convenience.

Statistical Hypothesis:

Profit planning can be made effective with the use of target costing

Statistical Tools used:

The Karl Pearson coefficient of mean square contingency {C} was used to find the association between “preference for adoption in target costing for decrease in cost” and “preference for adoption in Target Costing for increase in Profit”.

The Karl Pearson coefficient is basically the measure of the association between two binary variables.

The other tools used are as follows:

a) The bivariate table showing the relationship between “preference for adoption of Target costing technique for decrease in cost” and “preference for adoption of Target costing for increase in profit”.

b) The marginal table for preference for adoption of target costing technique for increase in profits.

Analysis:

Among the fifty six companies companies that were surveyed, fifty one companies responded “yes” to the question ‘do you recognize the need for adopting the pricing technique-target costing”. Amongst these fifty one companies, forty seven companies had responded that they had actually used the target costing technique.

The responses of these forty seven companies for the question “How has target costing benefited your company? Please rank in order of your preference where 1= Extremely Important” was analysed.

The responses were recorded in a bivariate table showing “preference for decrease in cost” and “Increase in profit”. The table is as follows:

Bivariate table showing preference for “decrease in cost” and “increase in profit”

X\Y

1

2

3

4

5

6

7

Total

1

*32

2

34

2

9

9

3

1

1

4

2

2

5

6

1

1

7

Total

47

X= Preference for adopting target costing technique in order to decrease the cost

Y= Preference for adopting target costing technique in order to increase profit

Outcome of using the Bivariate table showing preference for decrease in cost:

It can be seen from the above table that thirty two of the forty seven companies adopting the target costing technique gave first preference (X=1) to “decrease in cost” and second preference (Y=2) to “Increase in profit”. So, basically the companies are concentrating more on reducing the costs of producing the goods. They want to make profits, but yet want the goods to be produced at the targeted reduced costs and sold at the targeted selling prices.

The next table shows an analysis of just Y- “Preference in increasing profits”

Marginal Table for preference in Increase in Profit (Y)

Preference for increase in profits (Y)

Number of Companies

Percentage Frequency

Cumulative Percent

1

11

23.40

23.40

2

32

68.09

91.49

3

3

6.38

97.87

4

1

2.13

100.00

5

_

_

100.00

6

_

_

100.00

7

_

_

100.00

Total

47

100.00

The outcome of using the Marginal table for preference in Increase in Profit (Y) is s follows: From the above table, we see that 23.40 % of the companies give first preference to increase in profits, which was achieved by implementing the technique of target costing. However, we also see that 68.09 % of the companies gave second preference to increase in profits, which was achieved by implementing the technique of target costing. It can therefore, be said that though most of the companies had given second preference to increase in profits, but yet the cumulative preference percentage is 91.49 % upto the second preference and this is quite a huge percentage and this therefore, shows that target costing is an effective tool to increase the profits and as well as an effective tool for planning of profits.

To find an association between X and Y, the Karl Pearson co-efficient of Mean Square Contigency {C} was used:

The formula for calculating C is as follows:

C=""

Where CHI-SQUARE=""

Maximum allowed value for C is 0.9528

The next table gives the observed frequencies of X and Y.

Table of Observed frequencies (O)

X\Y

1

2

3

4

5

6

7

Total

1

*32

2

34

2

9

9

3

1

1

4

2

2

5

6

1

1

7

Total

11

32

3

1

47

The next table is the table of expected frequencies (E):

Table of Expected Frequencies (E)

X\Y

1

2

3

4

5

6

7

1

23.15

2.7

2

2.11

3

0.02

4

0.47

5

6

0.06

7

The outcome obtained through the use of the above two tables:

E for {i,j}th cell=[{ith row total} *{jth column total}]/ Grand total

Where Grand total=

Chi-square=112.6425

C=0.8399

Thus, we can see that the calculated value of C (i.e. 0.8399) is less than the maximum permissible value of C (theortical value) which is 0.9258. Thus, this shows that there is a strong positive association between the two attributes-X and Y

Thus the stated hypothesis “Profit planning can be made effective with the use of target costing” holds good. In other words, target costing is an effective tool or a technique for cost reduction and planning of profits.

Conclusion:

Although target costing in its simplest form is just a calculation:target price-margin, but yet today’s competitive world makes target costing an important strategic management technique. It can be successfully integrated into new product development and portfolio management process to provide the firms the economic and strategic benefits. An important element to be considered here is that the benefit of abandoning projects which are not economically viable in today’s competitive markets and also focusing typically the limited resources on those opportunities which will in turn provide adequate returns to the company. Target costing gives the necessary guidance on how to create a sustainable competitive advantage for a firm.Old ways of costing can have a negative impact and hinder the ability of companies to focus on world class performance. But by using the technique of target costing, effective costs can be obtained and good profits can also be obtained as a result of applying the target costing technique. On the whole, it can be said that putting in effort to improve quality and increase profits surely bears some cost which can be huge at times, but the cost of not making the effort will have an extremely adverse effect on the profitability of the company.

Comments:

  • Target costing is an intelligent technique that makes sure that the price of the products are controlled well and that the profits made due to the application of this costing technique are also substantially good.
  • The technique of target costing has been applied by many well known manufacturing companies belonging to various sectors.

Some of these companies are Toyota, Nissan, Benz, Cannon, Olympus and so on. It is known to us that these companies are very good in terms of the quality of goods these companies provide to their customers and the fact that these companies apply the technique of target costing can also imply that target costing apart from being an effective tool for cost reduction is also an effective tool for profit planning and quality improvement.

Learnings:

  • Companies must take up effective cost control measures as well as make sure that the quality of their products is not compromised. Adopting the above stated measures will help satisfy and meet the customer requirements. Such effective measures can help companies achieve reasonable profits on the products sold.
  • In the early stages of development and design cycle, a competitive selling price for a product is determined through various ways such as by taking inputs from the customers, finding out about the prices charged for the products by the competitors. From the competitive selling price that is set thereafter, an expected profit margin is subtracted from this competitive selling price to obtain the target cost of the of the product that is to be actually developed and produced in the later stages.
  • Target costing proved to be an effective tool for profit planning as well as an effective tool for cost reduction for many manufacturing companies such as Nissan, Toyota, Daihatsu and so on.
  • Target costing is not just a tool for cost reduction, but it is also an effective tool for profit management since it provides ample of opportunities for substantial growth in profits for the companies applying the target costing technique.
  • The target costing tool acts also acts a differentiator tool. The reason as to why it takes up the role of a differentiator is that the companies that adopt the technique of target costing have a competitive advantage over those companies that don’t adopt this technique. The reason being that through target costing technique one can anticipate the selling price at which the product can be sold to a customer such that the expected profit margin can be obtained.

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