Definition and Explanation:
Margin of safety (MOS) is the excess of budgeted or actual sales over the break even volume of sales. It stats the amount by which sales can drop before losses begin to be incurred. The higher the margin of safety, the lower the risk of not breaking even.
Formula of Margin of Safety:
The formula or equation for the calculation of margin of safety is as follows:
[Margin of Safety = Total budgeted or actual sales − Break even sales]
The margin of safety can also be expressed in percentage form. This percentage is obtained by dividing the margin of safety in dollar terms by total sales. Following equation is used for this purpose.
[Margin of Safety = Margin of safety in dollars / Total budgeted or actual sales]
Example:
Sales(400 units @ $250) $100,000
Break even sales $87,500
Calculate margin of safety
Calculation:
Sales(400units @$250) $100,000
Break even sales $ 87,500
---------
Margin of safety in dollars $ 12,500
=======
Margin of safety as a percentage of sales:
12,500 / 100,000
= 12.5%
It means that at the current level of sales and with the company's current prices and cost structure, a reduction in sales of $12,500, or 12.5%, would result in just breaking even. In a single product firm, the margin of safety can also be expressed in terms of the number of units sold by dividing the margin of safety in dollars by the selling price per unit. In this case, the margin of safety is 50 units ($12,500 ÷ $ 250 units = 50 units).
Review Problem:
Voltar company manufactures and sells a telephone answering machine. The company's contribution margin income statement for the most recent year is given below:
Description
Total Per unit Percent of Sales
Sales (20,000 units) $ 1,200,000 $60 100%
Less variable expenses 900,000 $45 ?%
--------- -------- --------
Contribution margin 300,000 $15 ?%
Less fixed expenses 240,000 ====== =====
---------
Net operating income 60,000
======
Required: margin of safety of safety both in dollars and percentage form.
Solution to Review Problem:
Margin of safety = Total sales – Break even sales*
= $1,200,000 – $960,000
= $240,000
Margin of safety percentage = Margin of safety in dollars / Total sales
= $240,000 / $1,200,000
= 20%
*The break even sales have been calculated as follows:
Sales = Variable expenses + Fixed expenses + Profit
$60Q = $45Q + $240,000 + $0**
$15Q = $240,000
Q = $240,000 / $15 per unit
Q = 16,000 units; or at $60 per unit. $960,000
Margin of safety (MOS) is the excess of budgeted or actual sales over the break even volume of sales. It stats the amount by which sales can drop before losses begin to be incurred. The higher the margin of safety, the lower the risk of not breaking even.
Formula of Margin of Safety:
The formula or equation for the calculation of margin of safety is as follows:
[Margin of Safety = Total budgeted or actual sales − Break even sales]
The margin of safety can also be expressed in percentage form. This percentage is obtained by dividing the margin of safety in dollar terms by total sales. Following equation is used for this purpose.
[Margin of Safety = Margin of safety in dollars / Total budgeted or actual sales]
Example:
Sales(400 units @ $250) $100,000
Break even sales $87,500
Calculate margin of safety
Calculation:
Sales(400units @$250) $100,000
Break even sales $ 87,500
---------
Margin of safety in dollars $ 12,500
=======
Margin of safety as a percentage of sales:
12,500 / 100,000
= 12.5%
It means that at the current level of sales and with the company's current prices and cost structure, a reduction in sales of $12,500, or 12.5%, would result in just breaking even. In a single product firm, the margin of safety can also be expressed in terms of the number of units sold by dividing the margin of safety in dollars by the selling price per unit. In this case, the margin of safety is 50 units ($12,500 ÷ $ 250 units = 50 units).
Review Problem:
Voltar company manufactures and sells a telephone answering machine. The company's contribution margin income statement for the most recent year is given below:
Description
Total Per unit Percent of Sales
Sales (20,000 units) $ 1,200,000 $60 100%
Less variable expenses 900,000 $45 ?%
--------- -------- --------
Contribution margin 300,000 $15 ?%
Less fixed expenses 240,000 ====== =====
---------
Net operating income 60,000
======
Required: margin of safety of safety both in dollars and percentage form.
Solution to Review Problem:
Margin of safety = Total sales – Break even sales*
= $1,200,000 – $960,000
= $240,000
Margin of safety percentage = Margin of safety in dollars / Total sales
= $240,000 / $1,200,000
= 20%
*The break even sales have been calculated as follows:
Sales = Variable expenses + Fixed expenses + Profit
$60Q = $45Q + $240,000 + $0**
$15Q = $240,000
Q = $240,000 / $15 per unit
Q = 16,000 units; or at $60 per unit. $960,000
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