Explain P/V ratio and Contribution.
P/V Ratio (Profit Volume Ratio) is the ratio of contribution to sales which indicates the contribution earned with respect to one rupee of sales. It also measures the rate of change of profit due to change in volume of sales. Its fundamental property is that if per unit sales price and variable cost are constant then P/V Ratio will be constant at all the levels of activities. A change is fixed cost does not affect P/V Ratio. It is calculated as under:
(Contribution * 100) / Sales
(Change in profits * 100) / (Change in sales)
A high P/V Ratio indicates that a slight increase in sales without increase in fixed costs will result in higher profits. A low P/V ratio which indicates low profitability can be improved by increasing selling price, reducing marginal costs or selling products having high P/V ratio.
It is the difference between sales revenue and variable cost (also known as variable cost). Variable cost is the important cost in deciding profitability as fixed costs are ignored by marginal costing.
It can be expressed in two ways:
• Sales Revenue – Variable Cost
• Fixed Cost + Profit
The situation generating higher contribution is treated as a profitable situation.