Margin of Safety

Margin of Safety (MOS) Definition

The difference between the actual sales volume. and the break-even sales volume is called the margin of safety. It represents that proportion of the current sale which determines the profit of the firm.

Formula to calculate the Margin of Safety

Margin of Safety = Actual sales volume – Break-even sales volume


How to calculate Margin of Safety ratio

Margin of safety ratio = (Actual sales – break-even sales) / Actual sales

Example

Calculate the margin of safety for five start enterprises from the below data:

Actual sales (4,000 units @ $25/unit) = $100,000
Contribution margin per unit = $15
Total fixed costs  = $25,000

As we know:

Margin of Safety = Actual sales volume – Break-even sales volume

So, first of all, we need to calculate Break-even sales volume as follows.

Break-even sales = Fixed Costs / Contribution margin per unit

= 25,000 / 15

= 1,667 units

= 1,667 x 25 = $41,675

Now we can calculate Margin of Safety as:

= 100,000 – 41,675

= $58,325

Or margin of safety in Percentage

= 58,325 / 100,000

= 0.5832

= 58.32 %

The Margin of Safety can be expressed as an absolute amount ($58,325) or as a percentage of sales (58.32%). The Margin of Safety ratio is an ideal index for ranking firms within an industry. Let us take the case of two firms showing exactly the same net income in their Income Statement but with a different Margin of Safety ratio. The firm with a high MOS ratio will withstand safely large decreases in sales volume while a firm with the low margin of safety will even with small decrease in sales volume start showing losses.

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