Price Variance: What It Means, How It Works, How To Calculate It

Let’s remember, for example, how the prices for travel services dropped during and immediately after the COVID-19 crisis. Purchase price variance (PPV) is a measure of the difference between the actual cost paid for a product or raw material and the standard cost that was expected to be paid. When the procurement team purchases materials for a very low price compared to the standard cost, which offsets the direct prices quantity variance because of the reduced material quality. It is the difference between the budgeted or standard price of an item and the actual amount paid to acquire that item.

How to improve purchase price variance

This value indicates the impact of fluctuations in purchase prices on the company’s finances. The purchase price variance is used to discover changes in the prices of goods and services. It can be used to spot instances in which the purchases being made differ in price from your planning levels. By using the variance, you can identify cases in which it can make sense to look for a different supplier, or to start pricing negotiations with an existing one. The variance can also indicate areas on which to focus when you want to reduce costs.

Examples of PPV in action

1. The company has changed suppliers for any number of reasons, resulting in a new cost structure that is not yet reflected in the standard.
2. It’s also helpful to introduce unified templates and common terminology for employees who will create documents.
3. You already know benchmarking and price tracking are important activities for a successful procurement practice.
4. Using procurement management software to streamline purchasing greatly improves the efficiency and cost effectiveness of ordering supplies and products.

What if we told you that you can drastically improve overall business profitability by looking at one specific procurement metric? It is a measure of the difference between the actual cost paid for a product or raw material and the standard cost that was expected to be paid. Understanding the relationship between the actual cost of the product, standards, and variances, along with potential consequences, as this can lead to better supply chain management. Companies often receive discounted prices when they purchase goods and services in large depreciation recapture quantities.

Negotiation

In instances where a budget is created and the actual material price isn’t known, the best estimate, known as “standard price”, is used in its place. Material purchases can account for up to 70% of a manufacturing company’s costs, so it’s important to create a budget and monitor it to ensure costs remain close to the projected spend. Price variances can be a result of numerous bookkeeping test measures knowledge of basic bookkeeping skills factors, so PPV can help measure product spending effectiveness. This calculation will help you understand how much money was saved (or lost) due to purchase price fluctuations.

Regular reviews of supplier contracts and maximizing offers like volume discounts can lead to favorable purchase price variances. Suppose Roxy Ltd is a company that budgets $1,000 as the standard cost to purchase a specific quantity of raw materials for production. However, a supplier offered them a promotional discount, and the company ended up paying only $900 for the same quantity. In this scenario, the company saved money compared to the anticipated expenses.

Formula

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. Purchase price variance (PPV) is a key indicator for procurement, offering insights about cost-savings and supplier-negotiation.

Think of it as a financial reflection of how a company’s purchasing strategies perform against market price fluctuations. Purchase price variance is an important metric for understanding fluctuations in price for goods and services. When used correctly, it provides vital insight into the effectiveness of the procurement organization in delivering on cost savings goals. A point to note is that a company may achieve a favorable price variance only by making a bulk purchase.

When procurement and finance departments don’t implement necessary control practices, they face the risk of employees making unapproved purchases in the company’s name that cost more than what was budgeted. Such purchases often include the most readily available items that are selected based on their delivery speed rather than on cost efficiency. Achieving a positive purchase price variance can result from effective negotiations between the purchasing team and suppliers.