PV Ratio Formula

PV Ratio Formula is Profit Volume Ratio Formula

This formula helps calculate the profits of a product.

Every Business Model seeks to profit by selling services or goods to customers. The first steps in this process are planning and preparation.

Budgeting is a component of such preparation. Budgets estimate the costs of acquiring raw materials, purchasing machinery, paying wages, maintaining equipment, and other expenses.

Then comes the estimation of profits and sales volume.

The PV ratio is a metric used to determine a product’s profitability. Let’s examine the formula and some examples.

PV Ratio means Profit Volume Ratio. This ratio helps express the relationship of Contribution to Sales, which is also called the Contribution to Sales ratio.

The Profit Volume ratio is helpful during the initial phase of business and facilitates the continuing business.

What’s the formula for the PV ratio?

Profit Volume ratio is expressed in terms of Contribution and Sales. It is also called the Contribution ratio.

Profit Volume Ratio = (Contribution/Sales)*100

Are you wondering what Contribution means?

Contribution is the sales revenue available to cover the fixed costs and profit.

The only thing that matters in a business is how much money the company makes in sales. Contribution is one metric that helps determine the sales revenue after reducing the variable costs.

Let’s understand how to calculate the contribution.

Contribution = Sales Revenue – Variable Costs

Therefore, the contribution is the amount that contributes to the remaining costs, which include fixed costs and profit.

So, Contribution also has a different formula, i.e., Contribution = Fixed Costs + Profits.

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PV Ratio Additional Formulas

We can replace the contribution element with Sales revenue and Variable costs in the Contribution ratio formula. Profit Volume ratio is expressed as

PV Ratio = (Sales – Variable Cost)*100/Sales

How about an example to help you understand the PV ratio?

ABC Company is a manufacturer looking to grow its business. The cost of expanding a business is enormous, so knowing how much money it will make is essential. As a result, the company is interested in learning more about how its sales ratio has changed over time.

Since that’s the case, the company wants to see if the current year’s PV ratio is consistent with last year’s. The information you need to compute the ratio is below.

• Sales = $10,000
• Variable Costs = $6,000
• Fixed Costs = $2,500
• Prior year PV ratio = 39%

1) Contribution = Sales – Variable Costs

                         = $10,000 – $6,000

                         = $4,000

2) PV Ratio = (Contribution/Sales)*100

                 = $4,000*100/$10,000

                = 40%

The above findings led us to conclude that the PV ratio is comparable to previous years.

Do we have any other ways to find the Profit Volume Ratios?

PV ratio can also be computed based on the change in contribution or profits and sales.

Profit Volume Ratio = (Change in Contribution/Change in Sales) *100

= (Change in Profits/Change in Sales) *100

Example

Happy Company manufactures soft toys. As the financial year-end approaches, the company wants to understand the Contribution ratio. However, it does not have complete information.

So, I requested your help to find out the PV ratio using the limited information below.

Contribution to Sales Ratio (based on Contribution amount)

= ($10,000 – $9,000)/($30,000 – $27,000)

= 33.33%

Note: Profit volume Ratio value will be the same irrespective of whether the contribution or profits are considered in the formulas

What are the advantages of the PV ratio?

• The profit volume ratio helps in decision-making. A higher PV ratio for the business is more favorable as it indicates high profits. Thus, it aids in understanding whether the company is moving towards or away from the profit zone.
  
  Think of a scenario where the entity runs multiple unrelated products. The business operations need to be strategic in expansion and optimizing resource (including capital) usage. Thus, the entity needs a measuring tool like the PV ratio to decide on the best allocation of resources in the business’s best interest.
  
• It also assists in calculating the contribution, profits, break-even point, and margin of safety.
• Businesses always focus on profit and wealth maximization. The strategic team checks multiple business models to maximize sales and profits. This team does quantitative analysis using various ratios, including the PV ratio. Thus, this ratio is utilized to understand the effect of a $1 increase or decrease in price or a change in sales or production quantity.

Also Read: True Up Journal Entry

Runners’ Insight#1

The break-even point is not just in quantity. We can also express it in terms of value. The formula for the break-even point is below.

BEP in Value = (Fixed Costs/PV ratio)*100

BEP in Sales Units =(Fixed Costs/Contribution per unit)

Runners’ Insight#2

The margin of safety is where the business moves into a favorable position, as an inflow of revenue contributes to the profits.

Similar to the break-even point, we can also express the Margin of safety in both value and sales units. Let’s see the formulas for it.

The Margin of Safety in Sales Units = Total Sales – BEP Sales

The Margin of Safety in Value = (Total Sales – BEP Sales)* Contribution per unit. (or) Profit/PV ratio

Also Read: Cash Coverage Ratio

Practical Examples

We understood all three concepts—Contribution Ratio, BEP, and Margin of Safety. However, theoretical knowledge does not suffice for a complete learning experience, so we will do a knowledge check of these concepts with an example.

Worry Ltd Company wants to find out the Profit Volume ratio, Margin of Safety, and Break-even point for the Current year. Details of Costs are below.

• Sales = 100,000 Units, and the Selling price is $30 per unit
• Variable Costs are $15 per unit
• Fixed Costs are $1,000,000

Contribution = Sales – Variable Costs = $15 per unit

Profit Volume ratio = (15/30)*100 = 50%

Break Even Point = Fixed Costs/PV ratio = $1,000,000/50% = 2,000,000

Margin of Safety = Total Sales – Break Even Sales = $1,000,000

Conclusion

Profit Volume ratio is expressed in terms of contribution to sales. This helps calculate contribution and various ratios like the Break-even point and the margin of safety. There are various applicable formulas for the PV ratio. The Most Common is Contribution over Sales multiplied by 100 to arrive at a percentage.

For entities with a multi-product business and limited capital, the PV ratio is a good metric for determining the most profitable business to invest in. A higher PV ratio implies increased profits.