What is profit-volume ratio?
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Profit-volume ratio, also known as the contribution margin ratio or P/V ratio, is a financial metric that measures the relationship between the contribution margin and sales. The contribution margin represents the portion of sales revenue that contributes to covering fixed costs and generating profit. The profit-volume ratio is expressed as a percentage and helps businesses understand how changes in sales volume impact their profitability.
The formula for profit-volume ratio is:
[ \text{Profit-Volume Ratio (P/V ratio)} = \left( \frac{\text{Contribution Margin}}{\text{Sales}} \right) \times 100 ]
The contribution margin is calculated by deducting variable costs from sales. The profit-volume ratio is particularly useful for financial analysis and decision-making, as it provides insights into the profitability of different levels of sales. A higher profit-volume ratio indicates that a larger proportion of sales contributes to covering fixed costs and generating profit, making the business more resilient to changes in sales volume. Conversely, a lower ratio signifies that a significant portion of sales is consumed by variable costs, impacting overall profitability.