Understanding the Meaning and Significance of PPV (Purchase Price Variance)

If you are someone who is a part of the business world, then you already know that benchmarking and price tracking are essential activities that you need to conduct for a successful procurement practice. The data derived from these activities offers you a point of reference through which you can understand the fair pricing of goods and services. 

However, it has also been observed that pricing structures and market conditions do change, and when they do, how can you determine if the procurement practice you are following is consistent? It is possible to use these metrics and interpret them when you’re measuring procurement success. 

In these situations, the majority of finance teams refer to the Purchase Price Variance, also known as the PPV, to find the answers. While the understanding of this metric is highly simple, it can have broad implications for your business and the performance it shows, which is why you need to be familiar with every single, small or big, aspect of PPV. 

Understanding the Meaning of Purchase Price Variance 

PPV is an important term that you need to know about if you are a part of the business world. This term is used to refer to the distinction between the standard cost of an item or service, compared to the amount that you actually paid to acquire it. PPV can either be beneficial or non-beneficial and can be tracked by companies for a special time period. The total procurement spend is used by others to report PPV. 

You should also be familiar with the fact that PPV is an important metric which is primarily used to understand the price fluctuations of goods and services, and when this metric is used correctly, you can get vital insight into the usefulness of the procurement organisation. 

Why Is Purchase Price Variance an Important Metric for Businesses?

Negotiating fresh purchases starts with understanding the usual cost of goods and services. Many times, procurement departments will evaluate offers based on accepted pricing or predetermined requirements.

Understanding the pricing range of products and services helps one to see how well cost-cutting strategies work as well. Seen in the appropriate light, PPV emphasises how well your procurement activities are going.

It should be underlined that a negative variation does not necessarily imply that there are flaws in the procurement strategy. Understanding the basic internal and external causes influencing variation requires context for data. Pricing, for instance, might be affected by outside market factors like supply chain restrictions. Prices may not be able to be negotiated down to the prior purchase price (LPP) when there are outside market hurdles.

What Is the Method to Calculate PPV? (Mathematical Equation to Understand PPV) 

Another important thing that you are required to know related to Purchase Price Variance is the method that is used to calculate the same. The calculation method is relatively simple, as you simply have the follow the method mentioned here. 

PPV = (actual price paid − standard price) × actual quantity

As we have already mentioned, PPV can either be favourable or it can b unfavourable, and here, you can use this equation to know how PPV affects a company in both these situations. Take a look at these examples that tell you the way you should use this equation to find out the PPV. 

Favorable Variance

Let’s imagine that the IT Team of a company needs to upgrade the equipment (laptops) of several members of the team. The department will then purchase 10 new laptops from a supplier they know and get a discount. This discount drops the price of the laptops from $2,200 per unit to $2000. Here, the PPV will be calculated in the following manner. 

Baseline cost: $2,200 × 10 units = $22,000

Actual cost: $2,000 × 10 units = $20,000

Hence, the PPV on this particular purchase is favourable, as it is $20,00 for 10 units. 

Unfavorable Variance

As a manufacturer, if you need to build a specific piece for a product that was previously only $1 per unit, but it has now increased by 50% based on its demand, then you will have an unfavourable PPV in the following manner. 

Baseline cost: $100 × 100 units = $10,000

Actual cost: $150 × 100 units = $15,000

Since the variance for 100 units is $5000, here the Purchase Price Variance is unfavourable.