In the last article, we have done the objectives of profit volume ratio, today we will discuss the concepts of the same. There are four concepts in profit volume or p/v ratio:
1) Contribution: contribution is the difference between sale and marginal cost i.e.
Contribution= sale – marginal cost
it is also calculated by contribution= fixed expenses+ profit
it is different from profit as it include fixed cost and profit and it is based on the marginal cost concept while profit does not include fixed cost and it is based on common cost concept.
2) Contribution/ sale ratio: more of contribution/sale ratio more will be the profit.
It is calculated by fixed expenses+ profit/sale
Or change in profit/ change in sale
Also Read: Objectives of profit volume ratio.
3) Breakeven point: when in a business there is no profit no loss then it is said to be breakeven. A company which earns breakeven early is better than the other companies. It is calculated by
Breakeven point (in units)=Total fixed expenses/ contribution
Breakeven point (total sales)=Fixed cost/ p/v ratio
4) Margin of safety: it is calculated by difference between actual sale and break even sale. The sale which cross breakeven point is known as margin of safety. It is calculated by
Margin of safety= profit/p/v ratio
Margin of safety= profit/ contribution per unit
Margin of safety gives profit after meeting fixed cost. If margin of safety is large it shows strength of the business if margin of safety is small, it is a serious matter as it leads to loss. Margin of safety can be increased by increasing the production, selling price and decreasing the fixed cost.