What Is Profit Volume Ratio(P/V Ratio)? With Example, Formula, And Uses

You may have an excellent idea to open a business or launch a product in the Company. Well, that’s good, and you will always wish to earn profit by selling products to customers. But for this, you have to make a few plan and preparation and then execute it to achieve profits.

First, You must consider the budget by estimating the machinery costs, raw materials, labor charges, etc. Secondly, you need to think about the profit and sales volume.

The Profit volume ratio (P/V ratio) plays an important role which will help determine any product’s profit. It is also called the contribution factor and is expressed as the ratio of contribution and sales. The ratio will help the investors to know whether the business is expanding or contracting.

In This article We Have discusses the Profit volume ratio P/V ratio and its importance in achieving profit while selling any product. So, keep reading it to know more regarding the information.

What Is Profit volume ratio (P/V ratio)?

Table of Contents

The P/V(Profit Volume) ratio determines how many products or units the Company has to sell to achieve profit. The selling price of any product can be determined by calculating the fixed and variable costs.

Fixed costs are costs the Company spends on assets highly required for producing the product. This cost is independent of the sales volume. Example machinery required for producing the product.

Variable costs are those costs that will vary according to the sales volume. For example, raw materials or inventories are required to produce any company product.

If a Company cannot sell any product, it has to incur fixed costs. But the Company will not incur any variable costs. A Company needs to sufficiently sell its product to cover its fixed and variable costs. The Profit volume ratio(P/V ratio) is a relation between contribution and sales. It is always multiplied by 100 to express it in percentage form.

Are you wondering what is contribution? Contribution is a metric that helps find out the remaining sales revenue after reducing variable costs.

So, contribution = Sales revenue – Variable costs

Profit volume ratio (P/V ratio) Formula With Examples

P/V ratio = (Contribution/Sales) *100

Contribution = Selling price – variable costs

Now let’s discuss an example.

Example1:

The selling price of a soft toy is Rs100. The variable cost is Rs70.

So P/V ratio will be {(100-70)/100}*100 = 30%

The above example clears that variable cost is an essential factor in deciding the profitability of any product.

Lowering the P/V ratio indicates a low-profit margin. The Company has to increase the selling price of the product to achieve profit in business.

Example:2

Let’s take the above example again and increase the selling price of the soft toy to Rs130.

So, now the P/V ratio will be {(130-70)/100}*100 = 60%

O this proves that if the selling price of the product increases without any change in variable costs, then the contribution factor increases, which ultimately increases the P/V ratio.

What Are The Ways To Improve the Profit volume ratio (P/V ratio)?

Every management should look for a way to improve the P/V ratio so that the business will have profit. You can enhance the Profit volume ratio (P/V ratio) in a few ways listed below.

Reduce variable costs required for producing the product
Increase the selling price of the product

Improve sale mix

Significance Of Profit volume ratio (P/V ratio) In Break-even Analysis

Starting a business is usually risky. You need first to spend more money to achieve profit. But this is not always true. There is one effective economic tool by which you can reduce the risks associated with business, i.e., Break-even analysis.

The break-even analysis will tell you how many units or products a company needs to sell to cover fixed and variable costs and achieve a profit.

The break-even point is where the Company will not incur any loss or profit but can regain the money it has spent on the product. Remember, your business will profit when it starts exceeding the break-even point. If the business revenue goes below the break-even point, the Company is incurring a loss.

Break-even point per product/unit = Fixed costs /(Selling price per unit – variable costs per unit)

Example:1

You have a toy store and want to do a break-even analysis. The fixed cost is Rs 6000, and the variable cost per toy is Rs 25. The selling price per toy is Rs 50.

Now the Break-even point is 6000/(50 -25) = 240 units of toys

The Company must sell 240 toys to achieve a break-even point.

Example:2

You can calculate the break-even point even though the Profit volume ratio (P/V ratio)

BEP(Break-even point) = Fixed Costs /PV ratio

The Company sales are Rs10,00,000 at Rs 10 per product. The fixed costs are Rs 2,50,000, and the variable costs are 6,00,000. The variable cost per product is Rs6.

P/V ratio = Contribution / sales

Contribution = sales volume – variable costs = 10,00,000 – 6,00,000 =Rs4,00,000

P/V ratio ={ 4,00,000/10,00,000}*100 = 40 %

Break-even point(In rupees) = fixed costs/PV ratio = 2,50,000/0.4 =Rs6,25,000

So, the Company sales must be Rs62500 to achieve the break-even point.

So Profit volume ratio (P/V ratio) helps determine the break-even point, which ultimately allows a Company to assess the profitability of the product and the services offered.

If we calculate the Break-even point (in units)= Fixed costs /Selling price per unit – variable costs per unit)

Break even point = 2,50,000/(10-6) =6,2,500 units.

The Company has to sell 62500 units to achieve the Break-even point.

Example 3:

The Company is spending Rs10,000 on fixed costs. The average selling price of a product is Rs100, and the variable costs per product are RS 20.

So, the contribution margin is Rs80.

Here the Break-even Point(In units) = Fixed cost/(selling price per product -Variable cost per product) =10,000/80 =125 units.

It indicates that a company must sell 125 units to achieve a break-even point. If it sells more than 125 units, the Company will have a profit. If the Company fails to reach its target or sells less than 125 units, it has to face loss.

Now let’s calculate the Break-even point in another way. The PV ratio is also involved in determining the break-even point.

Here in this example, the PV ratio is 80%

So, BEP(In Rs) = Fixed price /PV ratio = 10000/0.8 = Rs 12,500

So the Company sales should be Rs 12,5000 to achieve the break-even point.

Significance Of Profit volume ratio (P/V ratio) In Margin Of Safety

The margin of safety is a crucial economic tool, significantly when the business is expanding or launching a new product. It mainly determines how much loss in sales or increased expenditure can be tolerated by the Company.

You can calculate the margin of safety by subtracting the break-even sales from the actual sales.

In other words, you can say the margin of safety is the sales revenue above the break-even point. If the margin of safety is high, then it indicates that the business is in good condition, which means the Company will have profit even if there is a decline in sales.

If the margin of safety is low, the business is not in good condition. A decline in sales volume may cause a loss in the industry.

If the margin of safety is lower because of an increase in fixed costs and contribution ratio, you need to reduce either the fixed price or increase the sales volume.

You can increase the margin of safety by following ways.

Increase In the selling price
Increase in sales volume

Lower the BEP by reducing the fixed cost.
Improve the contribution price by increasing variable costs.

Let’s discuss the margin of safety with an example.

Example1:

We will take here the same example as described above. The Company has sales of Rs10,00,000 at Rs10 per unit. The fixed cost is Rs2,50,000, and the variable cost is Rs6,00,000.

The margin of safety = Actual sales -Break-even sales

We have calculated Break-even sales as Rs 6,25,000

Actual sales = Rs10,00,000

The margin of safety = 10,00,000 -6,25,000 = Rs3,75,000

You can even calculate the margin of safety through another formula, i.e., by PV ratio.

Here the PV ratio is 40 percent.

The margin of safety = Profit /PV ratio

Profit = Total sales – (Fixed cost + Variable costs)

Profit = 10,00,000-(2,50,000 +6,00,000) = Rs1,50,000

Margin of safety = 1,50,000/0.4 = 3,75,000

Example 2:

Consider a company that is selling only one product

The selling price per unit of a product Is Rs 100. Actual sales are Rs4,00,000. The Break-even sales are Rs 1,00,000

The margin of safety = Actual sales -Break-even sales = 4,00,000 – 1,00,000 = Rs3,00,000

Uses Of Profit volume ratio (P/V ratio)

PV ratio helps in finding out the margin of safety. It is an amount below which the business can no longer achieve profit. The value enables the management to access the risk factors that the Company may face due to changes in sales volume. The marketing team can make other promotional strategies to increase the sales volume to achieve a margin of safety.

PV ratio helps to find the break-even point. It is the sales amount where the business will not have to undergo any profit or loss. Start-up businesses are considered to be better if they achieve the break-even point. But remember moving ahead of break-even sales will help a Company to achieve profit.
It helps to find out the profit at any sales volume.

Profit =Contribution – Fixed cost

Contribution = P/V ratio *sales

Contribution = Sales Revenue -Variable costs

It helps to find out the sales to achieve a particular profit.

Sales =(Fixed cost +desired profit)/PV ratio.

You can compare two or three products produced by the Company in terms of sales volume, and the margin of safety can be quickly made by calculating the P/V ratio.

Example

Suppose a company is manufacturing three products, i.e., products A, B, and C.

Product	Selling price	Variable Costs
A	Rs10,000	Rs5000
B	Rs20,000	Rs15,000
C	Rs40,000	Rs25,000

1.Contribution for Product A = Selling price – Variable costs = Rs5000

P/V ratio = Contribution/Sales volume = (5000/10,000) *100 = 50%

Marginal cost ratio = 1-P/V ratio = 1-50% = 50%

Contribution for product B =Rs5000

P/V ratio = (5000/20,000)*100= 25%

Marginal cost ratio = 1 – P/V ratio = 1-25% = 75%

Contribution for product C = Rs15,000

P/V ratio = (15000/40000)*100 =37.5%

Marginal cost ratio = 1-P/V ratio =62.5%

The above example proves how the P/V ratio and marginal cost ratio vary on varying the selling price and variable costs of any product.

What Is a PV Chart?

The PV (profit volume) chart represents the sales and profit achieved in business. It is helpful for a company to view the break-even point in a graphical representation.

Conclusion

Are you managing a business? If yes, then you should consider the P/V ratio. It is a necessary economic tool that will help your business to make correct decisions and helps in achieving profit.

It will help to estimate how much profit the Company will have per unit of sales volume. The powerful tool can even help to calculate the margin of safety and break-even point, which will significantly help to have profit. Calculating the profit volume ratio can help the business to fix goals and plan the budget accordingly.

So, in short, you can say the Profit Volume Ratio (P/V ratio) helps to make proper decisions in business and optimize the costs to achieve profit. Thank you for reading the article.