The profit volume ratio or P/V ratio is the ratio or percentage of contribution margin to sales. This ratio is also known as marginal income ratio, contribution to sales ratio or variable profit ratio. The profit volume ratio usually expressed in percentage is the rate at which profit increases with the increase in the volume.
The profit volume (or contribution-sales) ratio is a logical extension of marginal costing. It is the study of the inter-relationships of cost behaviour patterns, levels of activity and the profit that results from each alternative combination. The significance of profit volume ratio may be enumerated from the following application which are as under:
- Ascertainment of profit on a particular level of sales volume.
- Determination of break-even point.
- Calculation of sales required to earn a particular level of profit.
- Estimation of the volume of sales required to maintain the present level of profit in case selling prices are to be reduced by a stipulated margin.
- Useful in developing flexible budgets for cost control purposes.
- Identification of minimum volume of activity that the enterprise must achieve to avoid incurring losses.
- Provision of data on relevant costs for decisions relating to pricing, keeping or dropping product lines, accepting or rejecting particular orders, make or buy decisions, sales mix planning, altering plant layout, channels of distribution specification, promotional activities etc.
- Guiding in fixation of selling price where the volume has a close relationship with the price level.
- Evaluation of the impact of cost factors on profit.