The purchase price variance is the variance created by the actual price paid to a vendor for material compared to the standard cost.
It can significantly impact your bottom line, so it’s essential to understand how to calculate it and what factors affect it.
This blog post will discuss what PPV is and how to calculate it. We’ll also look at some factors influencing it and tips to minimize PPV.
What is PPV?
The purchase price variance (PPV finance) is the difference between the purchase price and the actual cost of a good or service. It is also known as purchase price variance analysis. It measures how much a company spends on goods and services.
Why does it matter?
For businesses, it can affect your bottom line and profitability. It is also vital for inventory management because you want to purchase items at the right amount, not too much or too little stock.
How to do the PPV calculation?
To calculate purchase price variance, you need to know the purchase price, the actual cost, and the quantity purchased.
purchase price variance formula is,
PPV = ( Standard price – Actual cost ) / Actual quantity
For example, if a company buys office supplies for $100 but the actual cost is only $80, the PPV would be calculated as ($100 – $80) /100 = 20%.
That means the company spent 20% more on office supplies than needed.
The general model for calculating a quantity variance is:
Quantity variance = (standard quantity – actual quantity)
This calculation tells you how much the actual quantity of products differs from the standard quantity. The result is expressed in terms of dollars or percentages. This information can be helpful when trying to identify reasons for discrepancies. For example, if the purchase order stated that 500 widgets were ordered, but only 450 were received, the quantity variance would be (-50).
Positive cost variance
Positive cost variance occurs when the actual unit price of an item purchased is lower than its purchase price. That results in a favorable PPV, saving the organization money on purchases.
For example,
An organization planned to purchase 10 mobile handsets to gift its employees. The purchase price of each handset is $500. But after negotiation with the supplier, the organization gets a handset for $400 each.
Now Purchase price is = $500 X 10 handsets = $5000
Actual cost is = $400 X 10 handsets = $4000
Let us calculate cost variance. Variance is $5000-$4000 = $1000
PPV on the purchase is positive and is a favorable variance of $1000 for 10 handsets
Reasons for It
- Negotiation with supplier
- Strategic supplier management
- Multi-year contract with the supplier
Negative cost variance
Negative cost variance occurs when the actual unit price of an item purchased is higher than its purchase price. This results in an unfavorable PPV.
Let us take the same example. The purchase price of each handset is $500. But, because of the increase in raw materials price, the supplier supplies each handset for $600.
Hence Purchase price is = $500 X 10 handsets = $5000
Actual cost is = $600 X 10 handsets = $6000
PPV on the purchase is negative and is an unfavorable variance of $1000 for 10 handsets.
Reasons for it
- Uncontrolled spending
- Item quantity variations
- Increase in raw material pricing
Factors that can impact PPV
Factors that can impact it include:
- Purchase quantity – if the buyer orders more products than expected.
- Purchase price – if the purchase price is higher or lower than expected.
- Purchase date – if it is earlier or later than expected.
- Shipping Terms – FOB (free on board) or CIF (cost, insurance, and freight) can affect which party is responsible for any variation in cost.
- Vendor discounts – if the buyer negotiates a deal with the vendor, that causes variance.
- Taxes – different tax rates in other states can cause it to vary.
- Product quality – if the product is of a lower or higher rate than expected, this will also affect it.
It’s essential to be aware of these factors to make informed decisions about your spending.
Examples of PPV in action
Example 1
For example, if a company orders 100 gadgets at a purchase price of $10 per widget, but the actual cost is $11 per widget, the variance would be ($10 – $11) / 100 = -$0.1 or -10%.
The company spent 10% more than it should have on the widgets.
Example 2
If a company orders 100 gadgets at a purchase price of $10 per widget, but the actual cost is $9 per widget, the variance would be ($10 – $9) / 100 = $0.1 or 10%.
The company saved 10% on the purchase price by ordering the gadgets lower than expected.
Tips for minimizing purchase price variance
- Compare prices before making a purchase
- Negotiate prices with suppliers
- Order smaller quantities to avoid overbuying
- Use purchase order forms to track orders and ensure accuracy
- Make sure you understand the shipping terms of your purchase
- Check for supplier discounts
- Stay up-to-date on market prices
- Keep track of purchase prices over time
FAQs
What is the price variance?
The price variance is the difference between the price at which a good or service is expected to be sold and the price at which it is sold.
Many factors influence price variance, including availability, demand, seasonality, and weather. In addition, in some cases, price variance can be caused by market manipulation or fraud.
How do you calculate purchase price variance in SAP?
To calculate PPV in SAP, you need to follow these steps:
1. Firstly, you need to identify the price variances for each purchase order.
2. To do this, compare the purchase order price with the standard purchase price.
3. Then, calculate the difference between the two amounts.
4. Finally, multiply this difference by the purchase order quantity.
When does the favorable cost variance occur?
The favorable cost variance usually occurs when the purchase price is lower than the actual cost.
What are direct materials price variances?
Direct materials price variance (DMPV) is the variance between the actual purchase price of materials and the standard cost. This variance can be positive or negative, depending on whether the purchase price was higher or lower than the standard cost.
It is calculated by subtracting the standard cost of material from the actual purchase price.
DMPV = (actual purchase price – standard cost)
This calculation will help you understand how much money was saved (or lost) due to purchase price fluctuations. It’s important to note that the DMPV includes only the direct materials in a product, not indirect materials.
Conclusion
PPV is the difference between a product or service’s purchase and selling price. This calculation considers discounts, rebates, allowances, and other deductions from the purchase price.
Understanding purchase price variance is essential for making sound pricing and inventory management decisions.
