Purchase Price Variance: Importance, Formula, Examples, Affecting Factors, and Much More

Running a profitable business with recurring profit margins is considered a miracle for new businesses, which is mostly possible with cost management of the procurement process. To evaluate this cost, we use a metric called purchase price variance, which determines the difference between the actual cost and the standard cost. 

But this evaluation is not as easy as it sounds. You need to keep the complete information on all the different aspects to hold on to it. So, get more into it and understand the purchase price variance meaning, formula, and factors affecting it.

What Does Purchase Price Variance Mean? 

Purchase Price Variance (PPV) is a performance metric that calculates and measures the difference between the standard expected cost and the actual cost of acquiring the same goods and services. It basically evaluates the expected expenditure a company was planning to make as compared to the actual one. This quantifies the efficiency of the procurement function of the company. 

It can either be calculated for one particular purchase made or for the total procurement made over a specific period. This tool is mainly used in cost accounting and standard costing, and hence, the difference is recorded in the ledger of the company. 

Also Read: What is Receivables Financing? Why is Accounts Receivable Financing Important for Businesses?

How Does Purchase Price Variance Help Businesses? 

The purchase price variance plays a significant role in the business processing and operations in the following ways: 

• Helps in Business Planning and Budgeting: By analyzing the variance in the expected and actual acquisition costs of goods and services, businesses evaluate the savings and overruns, which help in budgeting and planning the business expenditure accordingly. 

• Controls the Cost: Not limiting the functions here, the purchase price variance also allows businesses to limit excess expenditure on acquisition by actively tracking inefficiencies in the procurement process. 

• Evaluation of Suppliers: Determining the variance in cost can actually be directly related to suppliers. The procurement team analyzes the acquisition costs from the different vendors and favors the one that offers a lower price than expected. 

• Forecasting: Calculating the variance in the actual cost and the expected cost makes the tracking of procurement easy, and thus, helps in predicting future costs. 

What is the Purchase Price Variance Formula and How to Calculate It? (With Examples)

Before directly hopping onto the process of calculating the variance, let’s first take a sneak peek at the purchase price formula and understand the terminologies deeply. 

Purchase Price Variance = (Actual price – Standard price) x Quantity 

Where, 

• The actual price is the price of acquisition from vendors. 
• The standard price is the expected acquisition cost. 
• The quantity refers to the quantity of goods and services purchased from the vendor. 

To further understand it deeply, here are a few examples to look at. 

1. XYZ Ltd. bought 100 units of goods from a vendor at $9 per unit. The standard and expected cost was $10 per unit. The purchase price variance here will be: 

Purchase Price Variance = (Actual price – Standard price) x Quantity
                                                        = (9 – 10) x 100
                                                        = –$100 (Favorable)

A negative variance states that the company has saved $100 on the deal. 

2. ABC bought 50 units of goods from their regular vendor at $15, and the standard cost was $10. The purchase price variance here will be: 

Purchase Price Variance = (Actual price – Standard price) x Quantity
                                                       = (15 – 10) x 100

                                                       = 5 x 100

                                                      = $500 (Unfavorable)

A positive variance states that the company overspent on the goods by $500. 

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What are the Different Outcomes of the Purchase Price Variance? 

While calculating your purchase price variance, you can mainly have 2 different outcomes, named favorable and unfavorable. Let’s see what these mean and their impact on businesses. 

1. Favorable Outcome 

An outcome is said to be favorable when the purchase price variance is negative, which means the actual price is less than the standard price. This ultimately means that the business saved the amount on the procurement process. 

A favorable outcome not only improves the profitability of the business but also increases budget flexibility and financial performance. 

2. Unfavorable Outcome 

When the purchase price variance is positive, the situation is said to be unfavorable. This means that the procurement is settled on a higher price than expected and results in an overrun of the business funds. 

An unfavorable outcome indicates the increased costs of the goods and services from suppliers. 

How to Improve the Purchase Price Variance? 

Strategies like regular spend analysis, spending control implementation, working on priorities and improving relations with suppliers may help to improve purchase price variance. Here is the detailed breakdown of strategies:

• Conduct Regular Spend Analysis: Spending analysis reduces the purchase price variance by providing insights into the spending patterns of procurement, identifying cost-saving opportunities, and enabling better negotiation with suppliers. 

• Implement Spending Control: Putting a control over the spending promotes better cost management and efficiency in the procurement process. Over to that, opting for this strategy also results in less overspending. 

• Prioritize Logistics: The involvement of shipping and warehousing costs in the purchase price variance is significant and can highly influence it. Thus, finding a cost-effective option is a must to reduce the procurement cost. 

• Improve Relations with Suppliers: Keep a healthy relationship with the suppliers to get insights into the price fluctuations before anyone else. This includes getting in contact with multiple suppliers, negotiating with them on good terms, etc. 

Also Read: What is Additional Paid in Capital? — Its Definition, Calculation, and Importance

What are the Factors Affecting the Purchase Price Variance?  

The factors affecting the purchase price variance are mainly categorized into two different types, named external and internal. Let’s take a deep look into them. 

1. External Factors 

• Inflation: A rising price of goods and services can also lead to higher procurement costs for a business. 

• Market Fluctuations: With an involuntary commodities price rise, a rise in the cost of raw materials, and fluctuation in market behavior, costs can also increase the cost of procurement. 

• Disruptions in Supply: Sometimes, uncertain events also increase the purchase price variance. These events are natural disasters, geopolitical instability, unexpected surges in demand, etc. 

2. Internal Factors

• Procurement Strategy: An ineffective procurement strategy can also lead to a higher procurement cost, ultimately, a rising purchase price variance. 

• Discounts and Rebates: Suppliers offer discounts and rebates on the purchase of goods and services if acquired in high quantities.  This could lower the procurement cost and purchase price variance. 

• Inventory Management: Many people don’t know that the cost of holding the inventory also increases the purchase price variance. Thus, clearing out the stored goods can reduce the PPV. 

Conclusion 

The purchase price variance is nothing but a metric to evaluate the difference between the actual price and the standard price of the procurement process. Calculating this aspect of the business helps in turning the overrun into savings and even increasing the savings from the procurement process. 

To control and make changes to the magnitude of purchase price variance, make sure to utilize the factors in your favor. 

Also Read: EBITA: Meaning, Uses, and How to Calculate EBITDA?

Frequently Asked Questions 

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