The P/V ratio: meaning, significance in decision making, and how to improve it

Meaning of the P/V ratio

The profit-volume (P/V) ratio, also called the contribution/sales ratio, expresses contribution as a percentage of sales. It shows how much of each rupee of sales is left, after variable costs, to cover fixed costs and earn profit.

P/V ratio = Contribution ÷ Sales × 100 = (Sales − Variable cost) ÷ Sales × 100

When two periods are compared at the same prices and costs: P/V ratio = Change in profit ÷ Change in sales × 100.

Example: if selling price is ₹50 and variable cost ₹30, contribution is ₹20 and the P/V ratio is 40 per cent.

Significance in decision making

1. Break-even point: break-even sales = Fixed costs ÷ P/V ratio.
2. Sales needed for a target profit: (Fixed costs + Target profit) ÷ P/V ratio.
3. Profit at any level of sales: Sales × P/V ratio − Fixed costs.
4. Margin of safety and its profit: Profit = Margin of safety × P/V ratio.
5. Comparing products, markets or channels: those with a higher P/V ratio contribute more per rupee of sales, which helps decide the sales mix when sales value (rather than another factor) is the constraint.
6. Pricing decisions: the effect of a price change on profit can be seen from its effect on the ratio.
7. Make-or-buy and shut-down decisions use contribution, of which the ratio is a summary.

How it can be improved

The ratio rises when contribution per rupee of sales rises:

1. Increase the selling price, where the market allows.
2. Reduce variable costs: cheaper materials, better material usage, higher labour productivity, lower variable overheads, without lowering the quality customers pay for (a cheaper input that raises complaints or returns costs more than it saves).
3. Change the sales mix towards products with higher P/V ratios.

The ratio cannot be improved by cutting fixed costs: fixed costs affect the break-even point and profit, but not the contribution earned on each rupee of sales.