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Margin of Safety

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8 views

Margin of Safety

Uploaded by

ghcatalin18
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Margin of Safety

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

sales, expressed as a percentage of budgeted sales. In equation form:

%Margin of safety = Budgeted (or actual) sales - break even sales

Budgeted sales

Assume in a company the actual sales are Rs. 60,000 and break-even sales are Rs.

48,000. Then the margin of safety is:

= 60,000 – 48,000 x 100 % = 20 %

60,000

This means that if sales volume is 20% less than the actual sales volume, the firm

would just breakeven. Managers use the margin of safety as an indication of the risk

inherent in a particular sales goal. The simple presumption is that the greater the margin

of safety, the lower the risk.

Significance of Fixed Costs on Break-Even Point

The greater the fixed expenses, the higher will be the break-even point. In the short

run, fixed costs cannot be immediately reduced to meet declining customer demands.

Certain fixed costs remain fairly constant, such as taxes, insurance, rent or lease costs,

depreciation, security and certain aspects of administration (accounting, supervision, and

marketing). Most of the fixed costs are essential in order to maintain the facilities and

environment of the organization. As sales revenue decreases and fixed costs remain fairly

constant, the earnings will naturally decline accordingly because of the fixed cost impact.

It is only logical to assume that an organization with greater fixed expenses must have

larger sales revenues to break even. If sales revenue increases, however, the organization

can increase its earnings position because the increased profit will more than offset the

fixed costs needs.

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