Production Management

The Applications of Profit Volume Ratio (P/V Ratio) and its Importance

The profit or loss situation of a firm can be represented by means of a P/V graph also. A P/V graph portrays P/V ratio of the firm. P/V ratio is the relationship percentage of contribution in terms Of sales or turnover. It is always expressed in percentage. It is also known as contribution to sales ratio. It is calculated as follows :

PV Ratio = Contribution/ Sales (OR)

P/V Ratio = (Sales – V.C)/ Salesx 100

Applications of P/V Ratio

P/V ratio plays a very important part in the solution of problems sought to be dealt with by the break-even analysis. It is very helpful in pricing policy, product analysis and profit planning. Here are some important applications of P/V ratio :

(1) Determination of B.E.P. :

B.E.P. = FC/ P/V Ratio

(2) Determination of Contribution Contribution = Sales x P/V ratio

(3) Determination of Margin of Safety : M.S. =Profit / P/V Ratio

(4) Determination of variable costs for any volume of sales :

V.C. = Sales (1 — P/V ratio)

(5) Determination of Profit or Loss : Profit = (Sales x P/V ratio) — F.C.

Or Profit = Margin of Safety x P/V ratio

% of profit = P/V ratio x M.S. % x 100

It will be clear from the following example Given that P/V ratio is 60%; M.S. is 70% and Percentage of profit is to be calculated :

% of profit = 60% x 70% x 100 =42%

(6) Determination of increase in sales to meet increased expenditure:

Additional sales required =Increased Expenses/ PV Ratio

(7) Calculation of change in the break-even point when non- variable cost are increased or decreased : Change in non—variable costs

Change in B.E.P. = Change in non—variable costs/PV ratio

(8) Determination of sales volume required to offset price reduction:

Net sales volume = F.C. + Pt. / New P/V ratio

(9) Determination of sales volume to produce desired profit :

Required sales volume = F.C. + desired profit/ PV ratio

Improving the PV Ratio

A high profit-volume ratio is always desirable. Hence every firm must try to maintain high P/V ratio or to increase it. If profit- volume ratio is lower, it can be improved in the following manner :

(1) Increasing the sales price.

(2) Decreasing the variable cost.

(3) Changing the sales-mix.

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