Margin of safety

Definition

Margin of safety is the difference between actual or expected sales and the break-even point. It measures how much sales can drop before a business incurs a loss.

5 Must Know Facts For Your Next Test

1. The margin of safety can be expressed in units, dollars, or as a percentage.
2. A higher margin of safety indicates lower risk of not covering fixed costs.
3. It helps managers understand the resilience of their operations to changes in sales volume.
4. The formula for margin of safety in dollars is Actual Sales - Break-Even Sales.
5. Operating leverage affects the margin of safety; high operating leverage means lower margin of safety.

Review Questions

• How do you calculate the margin of safety in dollars?
• Why is a high margin of safety advantageous for a company?
• What impact does operating leverage have on the margin of safety?

Related terms

Break-Even Point:

The level of sales at which total revenues equal total costs, resulting in zero profit.

Operating Leverage:

A measure indicating how a change in sales volume will affect profits due to fixed and variable costs structure.

Contribution Margin:

The amount remaining from sales revenue after variable expenses have been deducted, contributing to covering fixed costs and generating profit.