Basic Marginal Cost Equation

S-V= F+P

Where S= Sales

F= Fixed Cost

V= Variable cost

P= Profit.

Profit /Volume Ratio – Profit Volume Ratio may be expressed as:-

P/V Ratio = (Sales – Marginal Cost of Sales )/ Sales

Or = Contribution/ Sales.

Or = Change in contribution/ Change in Sale

Or = Change in Profit/ Change in Sale

Suppose the sale price and marginal cost of a product are Rs20 and Rs 12 respectively, The P/V Ratio will be (Rs 20-Rs12) X100 = 40%

P/V Ratio remains constant at different levels of operation. A Change in fixed cost does not result in change in P/V ratio since P/V expresses relationship between contribution and sales.

Advantages of P/V Ratio –

i) It helps in determining the break even point.

ii) It helps in determining profit at various sales levels.

iii) It helps to fins out the sales volumes to earn a desired quamtum of profit.

iv) It helps to dertermine relative profitability of different products, processes and deoartments.

Limitations of P/V Ratio-

i) P/V Ratio heavily leans on excess of revenue over variable cost.

ii) The P/V Ratio fails to take in to consideration the capital outlays required by the additional productive capacity and the additional fixed cost, tha t are added.

iii) Inspection of P/V ratio of products can suggest profitable product lines that might be emphasized and unprofitable lines that may be re-evaluated or eliminated. Mere inspection of P/V ratio will not help to take final decision. For this purpose, analysis has to be broadened to take in to consideration differential cost of the decision and opportunity cost etc, . Thus it indicates only the area to be probed.

iv) The P/V ratio has been referred to as the questionable device for decision-making because it only gives an indication of the profitability of the product/product lines: that too if other things are equal, P/V ratio is good for forming impression and not for making decision.