The profit volume ratio, the PV ratio, is the most common tool accountants use to boost the business’s productivity. Additionally, with this particular ratio’s help, accountants ensure that the company produces and sells the most profitable mix of products or services. The PV ratio formula measures the relationship between contribution and sales, further expressed in percentages.
What is Meant by PV Ratio?
PV or profit and volume ratio, also known as the contribution or marginal ratio, basically represents the relationship between contribution and sales. In simple words, you could say that it shows the rate at which profit increases with volume.
When it is high, the profit margin is high. A low one is indicative of a relatively more minor profit margin. In circumstances of low margin, the business must either raise the selling price to enhance the PV ratio or increase the sales volume in order to generate a reasonable profit. A situation with a high PV ratio is known as a profitable situation.
To better understand this, it is essential to know what contribution and sales are.
- Contribution is excess of sales over variable cost.
- Sales refer to the number of products or services the business sells.
Suppose a company sells product A for $150 with variable costs of $100, the contribution calculated for one unit is $50, which is higher than that of another product- Product B’s contribution, i.e., $25. However, when the variable cost is divided by sales price, the P/V of product A will be 66.6% compared to the P/V of product B, i.e., 71.4%. Based on the P/V ratio, product B is more profitable than product A.
When two results- contribution and profit/volume ratio are available with the accountant, the P/V will always be the better indicator for making efficient business decisions.
It can be calculated by dividing the selling price less the variable costs by the selling price. Then the result is multiplied by 100 to express the calculated P/V as a percentage.
Following is the PV ratio formula:
P/V ratio = contribution / sales, or
= change in contribution / Change in sales, or
= Change of Profit / Change in sales
What is its Importance?
One of the paramount importance of the profit/ volume ratio is that it is mainly used by businesses to measure the profitability of each product or group of products being manufactured or bought for reselling purposes. In addition, the accountants also use this to measure the profitability of each production process, center, and operation.
Here are its applications in business and its other uses.
Application in business:
This is often considered a calculation of the business’s marginal cost. It is the high P/V ratio that establishes that the company achieves high margins in every sale made by it.
- First, the accountant uses the PV table to understand the optimum level of the fixed cost compared to the variable cost.
- Next, the P/V table subparts determine the sales volume for the break-even point (BEP).
- Finally, the sub-parts are further used to determine the degree of total leverage.
- Determining profit at a different level of sales
- Determining sales to earn the pre-specified amount of profit
- Determining the margin of safety
The profit and volume ratio holds a greater significance for the businesses as it helps make decisions resulting in increased productivity. Therefore, it is essential for each employee working in the business world. For example, a knowledgeable company striving to improve its P/V ratio for a particular product can either increase its selling price or reduce its variable costs.