What is PPV? (Plus how to calculate it and examples)
By Indeed Editorial Team
Published 14 November 2022
The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.
The purchase price variance, or PPV, is a crucial metric for companies that purchase products or services. Procurement teams use the PPV and other key metrics to measure how much the price of the goods and services they purchase varies over time. Understanding what PPV is and how it impacts company finances can help you to manage an organisation's spending and maintain its profits. In this article, we answer 'What is PPV?', outline what causes variances in the purchase price of products and services, discuss why organisations use PPV, explain how to calculate it and review some examples.
What is PPV?
In answer to 'What is PPV?', it measures the difference between a purchased item's actual cost and its expected or standard cost. When calculating the PPV, assume that the product quality is consistent and that neither the items' delivery nor the quantity of the items purchased impacts the cost. The actual purchase price is the amount of money the organisation actually spends on that item, whereas the standard purchase price is the price that a procurement team believes is the typical price during the planning or budgeting stages.
The PPV helps organisations calculate whether they've made a profit or loss when purchasing products, which may have a significant impact on a business's overall finances. For example, if the actual price an organisation pays for an item is lower than the standard price, this is a positive PPV. This indicates the organisation profits from the item's purchase. In contrast, if the actual price an organisation pays for an item is higher than the standard price, this is a negative PPV. This indicates the organisation has made a loss on the item's purchase.
What causes variances in the purchase price?
Many people often assume that an item's standard price is what procurement teams pay, but the actual price varies regularly due to market conditions, temporary discounts or the procurement team's effectiveness. These factors cause significant fluctuations in cost that may have serious consequences for businesses. Some possible reasons for a positive PPV, where the price paid is lower than the standard price, include:
excellent price negotiation by the procurement team
superior procurement strategies and price comparisons
decrease in the cost of materials across the market
low demand for items
discounts applied to large volume orders
procurement teams purchase lower quality products than before
Conversely, some possible reasons for a negative PPV, where the price paid is higher than the actual price, include:
increase in the cost of materials across the market
higher demand for items
lower bargaining power for procurement teams
lack of a discount due to a small order
inefficient procurement strategies and decisions
procurement teams purchase higher quality products than before
Why do organisations use PPV?
PPV is a commonly used financial metric that helps organisations to understand the price of goods bought, the cost of goods bought and gross profits. For many organisations, particularly those in industries like manufacturing, the cost of material purchases may make up a significant proportion of all operational costs. Due to this, understanding the standard price of these purchases and using the PPV to compare these costs to the actual price is key to increasing efficiency and reducing an organisation's costs. Some of the benefits of using PPV include:
helps organisations gain an accurate measurement of a good's actual price
allows organisations to evaluate a procurement team's efficiency
supports annual financial planning
benefits the development of business profitability strategies
motivates procurement teams to negotiate a fair market price
increases the accuracy of future budgets and price estimates
How to calculate PPV
Find out how to calculate PPV by following these steps:
1. Calculate the standard purchase price
To calculate the PPV, it's first necessary to calculate the standard purchase price. There are multiple different ways to calculate the standard or baseline purchase price, although some procurement teams may use the prior year's last purchase price (LPP), the current year's first purchase price (FPP) or an average of these two measurements. When calculating the standard purchase price, consider any recent developments that may affect the price. For example, a sudden and unexpected drop in supply may lead to an artificially high price for a short period.
2. Multiply the actual quantity by the standard purchase price
Once you've determined the standard purchase price, multiply the number of items you're planning to purchase by the standard purchase price to calculate the total standard purchase price. For example, if you're purchasing 150 metal sheets at £5 per sheet, the total cost of the purchase at the standard price is £750. This baseline figure provides procurement teams with a maximum price to aim for when negotiating prices with suppliers.
3. Multiply the actual quantity by the actual purchase price
Next, calculate the total cost of the purchase at the actual price. The actual price is the price you've agreed to pay per item and this includes any discounts or reductions the buyer and the seller have agreed upon. To complete this calculation, multiply the actual price by the number of items purchased.
For example, if you agree to buy 150 metal sheets at a discounted price of £4.50 per sheet, the total cost of the actual purchase is £675. In this scenario, it's clear from the individual unit price the organisation is making a saving on the item's price, but completing the next step allows procurement teams to determine how much they're saving.
4. Subtract the total actual purchase price from the total standard purchase price
The final stage of calculating the PPV involves subtracting the total actual purchase price from the total standard purchase price. At this stage, a positive number shows that the actual purchase price is lower than the standard purchase price, which results in a profit on the item's cost. Conversely, a negative number shows that the actual purchase price is higher than the standard purchase price, resulting in a loss on the item's cost.
For example, subtracting the actual price of 150 metal sheets at £4.50 each from the standard price of 150 metal sheets at £5 each returns a net positive of £75. This is a good PPV because it shows the organisation has made a £75 saving or profit on the order's total cost. The final calculation looks like this:
PPV = (Actual quantity x standard price) - (Actual quantity x actual price)
Below are two examples of PPV calculations that can help you better understand how to use the PPV formula:
Here's an example depicting how a beauty company might calculate PPV:
Cally's Brows is a beauty business based in Bristol. Every six months, Cally invests in disposable wax applicators, and she wants to calculate the PPV of her recent purchase. She determines that the standard price of a box of 10 wax applicators is £3, and she wants to purchase 50 boxes. Unfortunately, she can't find any applicators at this price, so she pays £3.50 per box for 50 boxes. Using the PPV formula, Cally calculates the PPV as follows:
Total standard price = £3 x 50 = £150
Total actual price = £3.50 x 50 = £175
PPV = £150 - £175 = -£25
In this scenario, her PPV is negative, which shows that Cally's purchase made her company a £25 loss.
Here's an example of how a manufacturing company might determine PPV:
Martin's Manufacturing is a manufacturing business based in Belfast. The business specialises in creating cable covers for various trades. Martin is purchasing large quantities of rubber sheeting to use in cable covers. He determines that the standard price of rubber sheets is £10 per square metre, and he purchases 500 square metres of rubber sheeting. Martin negotiates with his supplier to bring the price down 10% on his large volume order, resulting in an actual purchase price of £9 per square metre. He calculates the PPV as follows:
Total standard price = £10 x 500 = £5000
Total actual price = £9 x 500 = £4500
PPV = £5000 - £4500 = £500
Here, Martin has a positive PPV, which shows that his purchase made his company a £500 profit.
Disclaimer: The model shown is for illustration purposes only, and may require additional formatting to meet accepted standards.
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