Learning Outcomes
- Calculate margin of safety
The margin of safety looks at how far above the break-even point a company’s sales are. The greater the difference, the more secure a company can feel about hedging against possible declines in sales. The margin of safety can be expressed as a dollar amount, a percentage, or a number of units.
Assume BlankBooks, Inc. is currently operating at a production/sales level of 2,900 units per month.
What is the margin of safety as a dollar amount?
Margin of safety in dollars = contribution margin at current production – break-even contribution margin
$4,930.00 – $3,400.00 = $1,530.00
| Units | $/Unit | Total | |
|---|---|---|---|
| Sales | 2,900 | $ 10.00 | $ 29,000.00 |
| Variable costs | 2,900 | $ 8.30 | 24,070.00 |
| Contribution Margin | $ 1.70 | Single Line4,930.00 | |
| Fixed costs | 3,400.00 | ||
| Operating income | Single Line$ 1,530.00Double line | ||
| CM ratio | 17.00% |
| Units | $/unit | Total | |
|---|---|---|---|
| Sales | 2,000 | $10.00 | $ 20,000.00 |
| Variable costs | 2,000 | $8.30 | 16,600.00 |
| Contribution Margin | $1.70 | Single Line 3,400.00 | |
| Fixed costs | 3,400.00 | ||
| Operating income | Single Line$ –Double line | ||
| CM ratio | 17.00% |
Margin of safety in units = current units – break-even units
2,900 – 2,000 = 900
Margin of safety as a percentage = margin of safety in dollars / contribution margin at current production
$1,530.00 / $4,930.00 = 0.310344827586207…
Rounded to the nearest ten-thousandth = 0.3103
Multiply by 100 to get percentage (per-cent literally means “per one hundred”)
0.3103 * 100 = 31.03%
Rounded to the nearest whole number = 31%
The margin of safety is 31%, which gives the company a significant cushion over its break-even point. The higher the margin of safety, and the more it exceeds the break-even point, the better.
Now, let’s check your understanding of the margin of safety.
