# Margin of Safety

The margin of safety is a measure of the difference between the actual (or budgeted sales) and the break-even sales.

It determines the level by which sales can drop before a business incurs in losses. In other words, the margin of safety is the cushion by which actual or budgeted sales may be decreased without resulting in any loss.

The higher the margin of safety, the safer the situation is for the business.

Margin of safety (MOS) is often expressed in percentage.

## Margin of Safety Formula

 Margin of safety = Actual sales - Break-even sales Actual sales

Note: Budgeted sales may be used instead of actual sales to measure the degree of risk of budgeted figures.

Margin of safety may also be expressed in terms of dollar amount or number of units.

 MOS in dollars = Actual sales - Break-even sales
 MOS in units = Actual sales - Break-even sales Selling price

Or, MOS in units = Actual sales in units minus Break-even sales in units.

## Example

The following information pertains to last month's records of ABC Company.

 Per Unit Total Sales (5,000 units) \$15 \$75,000 Less: Variable Costs 5 25,000 Contribution Margin \$10 \$50,000 Less: Fixed Costs 20,000 Operating Income \$30,000

The break-even is properly computed at 2,000 units.

 BEP in Units = Total Fixed Costs = \$20,000 CM per Unit \$10 BEP in Units = 2,000 units

At 2,000 units, sales revenue is equal to \$30,000. This is the break-even sales, which can also be computed by dividing the total fixed costs of \$20,000 by the CM ratio of 10/15. Suppose the budgeted sales revenue for this month is the same as last month, \$75,000. The margin of safety would be:

 Margin of safety = Budgeted sales - Break-even sales Budgeted sales = \$75,000 - \$30,000 \$75,000 Margin of safety = 60%

This means that sales revenue can drop by 60% without incurring losses. This percentage sets the safety cushion for the business. If sales decrease by more than 60% of the budgeted amount, then the company will incur in losses.

When expressed in dollars and units, the margin of safety would be:

 MOS in dollars = Actual sales - Break-even sales MOS in dollars = \$75,000 - \$30,000 = \$45,000
 MOS in units = Actual sales - Break-even sales Selling price MOS in units = \$45,000 = 3,000 units \$15

Sales may be decreased by \$45,000 or 3,000 units from the budgeted sales without resulting in losses yet. If it decreases by more than \$45,000 (or by more than 3,000 units) the business will incur in losses.

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