Contribution/Sales Ratio or P/V Ratio
The profitability of the operation of a business can be known with the help of profit/volume ratio. Profit/volume ratio establishes the relationship between contribution and sales. Any increase in contribution leads to increase in profit because fixed cost is assumed to be constant for all the levels of production. Profitability of the product can be ascertained by comparing the P/V ratios for the different products. Higher the P/V ratio higher the profit and lower the P/V ratio lower is the profit. A higher P/V ratio is an indicator of sound financial health of the company's product.
The profit/volume ratio is expressed in percentage. It is expressed in the following ways:
Desired sales, variable cost and contribution can be found out with the help of P/V ratio. The formulae are as follows:
Desired Sales = Desired Contribution/P/V Ratio (or)
= (Fixed Cost + Desired Profit) / P/V Ratio
Variable Cost = Sales (1 - P/V ratio)
Contribution = Sales x P/V Ratio
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