Contribution, Margin of Safety and Profit volume ratio
CONTRIBUTION
The contribution is the difference between the sales and the variable costs. This is also known as gross margin. The formula to compute these values are,
Contribution = Sales – Total Variable costs
Contribution/unit = Selling price/unit – Variable cost/unit
MARGIN OF SAFETY
The margin of safety (M.S.) is the sales over and above the break-even sales. Margin of safety can be expressed in absolute sales amount or in percentage.
Margin of safety (M.S.) = Sales – Break-even sales
= (Profit / Contribution) * sales
Margin of safety (M.S.) as a per cent of sales = (M.S./Sales)*100
PROFIT / VOLUME RATIO (P/V RATIO)
Profit volume ratio also known as P/V ratio. It gives the relationship between contribution and sales. This is also known as contribution – sales ratio, marginal income ratio and variable profit ratio.
The different formula for the P/V ratio are as follows:
P/V ratio = Contribution / Sales
= (Sales – Total Variable costs) / Sales
The relationship between Break - even point (BEP) and P/V ratio is as follows:
BEP = Fixed cost / (P/V ratio)
The relationship between Margin of safety (M.S.) and P/V ratio is as follows:
M.S. = Profit / (P/V ratio)
