Management Accounting- Contribution and P/v Ratio

The Profit/volume ratio, which is also called the ‘contribution ratio’ or ‘marginal ratio’, expresses the relation of contribution to sales and can be expressed as under:


P/V Ratio = Contribution/Sales
Since Contribution = Sales – Variable Cost = Fixed Cost + Profit, P/V ratio can also be expressed as:
P/V Ratio = Sales – Variable cost/Sales i.e. S – V/S
or, P/V Ratio = Fixed Cost + Profit/Sales i.e. F + P/S
or, P/V Ratio = Change in profit or Contribution/Change in Sales

This ratio can also be shown in the form of percentage by multiplying by 100. Thus, if selling price of a product is Rs. 20 and variable cost is Rs. 15 per unit, then P/V Ratio = 20 – 15/20 × 100 = 5/20 × 100 = 25%
The P/V ratio, which establishes the relationship between contribution and sales, is of vital importance for studying the profitability of operations of a business. It reveals the effect on profit of changes in the volume.
In the above example, for every Rs. 100 sales, Contribution of Rs. 25 is made towards meeting the fixed expenses and then the profit comparison for P/V ratios can be made to find out which product, department or process is more profitable. Higher the P/V ratio, more will be the profit and lower the P/V ratio, lesser will be the profit. Thus, every management aims at increasing the P/V ratio.
The ratio can be increased by increasing the contribution. This can be done by:
(i) Increasing the selling price per unit
(ii) Reducing the variable or marginal cost.
(iii) Changing the sales mixture and selling more profitable products for which the P/V ratio is higher.

The concept of P/V ratio is also useful to calculate the break-even point, the profit at a given volume of sales, the sales volume required to earn a given (or desired) profit and the volume of sales required to maintain the present profits if the selling price is reduced by a specified percentage.
The formula for the sales volumes required to earn a given profit is:
P/V Ratio = Contribution/Sales
or, P/V Ratio = Fixed Cost + Profit/Sales
or, Sales = Fixed Cost + Profit/P/V ratio = F + P/P/V ratio
Illustration 1:
Profit with Illustration 6
Find out:
(i) P/V ratio,
(ii) Fixed Cost
(iii) Sales Volume to earn a Profit of Rs. 40,000
Solution:
Solution
Proof:
Proof
Illustration 2:
Sale of a product amounts to 200 units per month at Rs. 10 per unit. Fixed overhead cost is Rs. 400 per month and variable cost is Rs. 6 per unit. There is a proposal to reduce prices by 10 per cent. Calculate present and future P/V ratio. How many units must he sold to earn the present total profits?
Solution:
Solution
Illustration 3:
The sales turnover and profit during two years were as follows:
Profit with Illustration 8
You are required to calculate:
(i) P/V ratio
(ii) Sales required to earn a profit of Rs. 40,000.
(iii) Profit when sales are Rs. 1,20,000.
Solution:
Solution
 

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