No matter which industry you are in, a lower product or material spending is always better than the opposite. A lower price means more flexible price changes and adjustment strategies, and more pricing room for your end products, thus earning you the competitive edges and better business growth. That said, saving more when sourcing for parts or products become all the more important.
But how can you tell how much your organization has saved, and how well you are in meeting the cost saving goals?
Purchase price variance (PPV) is such a metric that gives you what you need.
What is purchase price variance (PPV)?
Just as the name suggests, purchase price variance (PPV) refers to the differences between two variables: the actual purchased product price and the standard product price, given a certain quality level, purchasing quantity and speed of delivery.
Here, the actual purchased product price is how much you actually spend for the product. While the standard product price refers to a price that engineers believe the company should pay for an item.
How to calculate purchase price variance (PPV)?
The formula for PPV is:
PPV = actual cost – standard cost
= actual quantity x actual price – actual quantity x standard price
If the actual cost is lower than the standard cost, you’re having a positive price variance, meaning that you’re saving money for your organization.
If the actual cost is higher than the standard cost, you’re having a negative price variance, meaning that you’re spending more for the products or parts.
If you’re still confused about the concept, move on and see a more detailed example.
Calculate purchase price variance (PPV) with an example
For example, if you are to purchase 100 computers, the whole or finished product, for your company, and the standard price is $499 each. The actual price you pay for is $490 each, and you buy a 100 of them.
Then the purchase price variance is the actual quantity (100) x actual price (490) – actual quantity (100) x standard price (499) = – $900, meaning that you have saved 900 dollars on the purchase.
Of course, this is just a very rough example, and the actual situation is much more complicated. Each variance in the formula can be affected by many factors.
Possible causes for purchase price variance (PPV)
A positive purchase price variance means that your company is gaining the cost competitiveness from the supplier. Here might be the reasons why:
- the purchase product is of lower quality than the standard;
- better pricing deal negotiated by the procurement team;
- better procurement strategies and practices, such as gathering bids from multiple suppliers;
- an overall decrease of material price;
- purchase discount due to large orders.
A negative purchase price variance means that the actual cost is higher than the standard cost, which is usually not something you want to see. If you want to repeatedly seeing it, one of the first things you do is to figure out why would a negative purchase price variance happens. Here are some of the reasons why:
- an overall increase of the market price for the material or product;
- the purchased products are of higher quality;
- your bargaining power decreased;
- inefficient buying decision made by the procurement team;
- loss of discounts due to small order volume.
That concludes what we have to say about purchase price variance in the post. Feel free to let us know if you’re interested in knowing more about it. If you have any question regarding the purchase price variance, feel free to reach out, and we’d be glad to help.
