Market prices of materials are constantly changing and it's difficult to determine a price that won’t fluctuate in coming weeks or months. In accounting, PPV accounts for the potential change in value of materials from when they’re purchased and when they get recorded on the books. Understanding PPV can help you stay on top of your accounting and maintain accurate bookkeeping records.
What is PPV?
The abbreviation PPV stands for “purchase price variance” and is a commonly used method by accountants to keep their books accurate and reflective of market prices. Estimated costs are essential for determining budgets, invoices, and accounting items, such as income and balance sheets. As prices for raw materials such as lumber, energy, minerals, and other raw materials are subject to change in price, it's difficult to forecast the estimated price of materials and factor it into those documents.
Many companies determine a standard cost of goods to be used as the estimated costs of goods when calculating their budgets and accounting documents. PPV is then used to show the difference between the actual price paid for goods and the estimated cost that the business established.
How to calculate PPV
PPV is simple to calculate and can show whether you over or under corrected your budget. To calculate PPV, you take the actual price of the item purchased and subtract the estimated cost you calculated at the beginning of the year. You then take this number and multiply it by the number of units purchased.
For example, Jay’s Renovations predicts it will need 200 planks of lumber for its upcoming building job. They estimate the cost of lumber to be eight dollars per plank. They factor this number into their budget and give their client a quote for the job. Two months later, when Jay goes to purchase lumber for the job, he notices the price of lumber has increased to nine dollars per plank. To calculate PPV, Jay subtracts what he estimated the price would be from the actual price he paid and multiplies it by the 200 planks he needs to complete the job.
He learns his price per variance is one dollar per plank, as he estimated each plank would be a dollar less than it actually was. After multiplying it by the 200 planks he purchased, his PPV is 200 dollars. Jay revisits his budget and invoices the customer for the additional amount of 200 dollars for supplies.
Recording PPV in your books
The way you enter PPV in your accounting records can vary depending on which methods you use. Typically, when a business places an order or begins a job, they can debit the account for the amount of the estimated cost of the goods. Once they make the last purchase, they can credit the account for that same amount. The remaining value is your PPV, which they can credit if positive, and debit if negative.
What does PPV mean?
After calculating your PPV, it can either be positive or negative. If your PPV is positive, it means the goods you purchased cost more than what you estimated. If your PPV is negative, it means your estimations were more than what you paid for goods. Both positive and negative PPV can impact your bottom line.
Positive PPV
Purchasing goods at a higher rate than what you estimated can affect your books. It’s important to revisit your budget and accounting records on a project basis so you can make adjustments in future projects. As you spend more of your budget, you have less to allocate to other projects, especially if your PPV is positive for those projects as well. If your work includes providing a service, you may need to adjust the quote you gave to clients as the cost of the job will increase. You can also use your PPV to change the estimated cost of future projects to be more reflective of market rates.
Negative PPV
Spending less on goods than you estimate typically means you have more in your budget to work with. This can help account for positive PPVs on future projects and can help to balance your budgets as the year progresses. Negative PPVs can be harmful to business operations as they can affect your ability to make use of economies of scale. If you could not purchase a set amount due to budget constraints and the cost of goods was lower than expected, you may have been able to make use of cost saving. Regardless, it’s important to update your future estimates as you calculate your PPV per project.
What influences PPV?
Several factors can influence the costs of goods, which can affect your calculations, such as PPV, including:
Inflation
Inflation is the primary driver of the cost of goods, especially in the raw materials sector. Inflation can cause an increase in the price of goods, which results in people buying less of the good and lowering the purchasing power of money. Cost-increases in raw materials can affect the price of finished goods in every industry and can be difficult to predict. Having flexibility in your budget can help account for unpredictable changes because of inflation when accounting for PPV.
Supply Shortages
Supply shortages can affect the cost of goods and, as a result, your PPV. When products are more in demand than the supply can keep up with, the prices of those products increases. When product demand is lower than supply, that product sits on store shelves longer until promotions bring the price down. Demand is another factor that is difficult to predict, as is the promotion of the goods. When calculating your estimated cost of goods, it’s good practice to assume stores will sell products at their full retail value and without promotion.
Supplier Changes
Depending on your industry, the negotiation power you hold can vary. Having multiple suppliers in your industry can bring down the cost of goods as suppliers compete for customer purchases. The expansion of the worldwide trading route has resulted in supplier options being global, which has brought down the price of goods. Consumers and manufacturers now have the option to work with suppliers from countries that directly produce raw materials, cutting out the need for their local suppliers. When possible, consider negotiating your pricing options with your supplier. Often, suppliers account for some negotiation about their pricing to prevent customers from taking their business elsewhere.
Product recalls
Product recalls can cause a drastic product shortage and they often happen without notice. If a business pulls thousands of products off shelves because of a manufacturer error, the sudden demand can cause the price of goods to rise. This can also lead to unavailability of some products, which can make it difficult for businesses to source their material. Having a second plan for materials can help avoid this situation in the event of an emergency and can help you operate during certain product shortages.
How to expect PPV in your budget
PPV can be difficult to predict as several factors impact the cost of goods. To ensure you maintain your records as accurately as possible, it’s important to find the right amount of flexibility in your budget. When determining your estimated cost of goods, look at the price fluctuations of those goods in the past year. Identifying patterns in pricing can help you forecast what the price will be at the time of year as your project. You can also look at global events that are disrupting market prices and account for changes. For example, if wildfires are rampant across British Columbia, you may see price increases in lumber and raw materials exported from that area over the next few months.
When creating your budget, ensure you leave room for extra costs and positive PPVs. These extra costs can add up when unexpected events drive the price of goods up. It’s better to have accounted for an extra room in the budget than to operate at a loss midway through the year. Additionally, it’s important to update your budget and books as projects are completed so you have an accurate picture of the impact prices have put on your budget. You may have a positive PPV one month and negative the next, causing your budgets to balance.