Margin of Safety (MOS)
In break-even analysis, margin of safety is the extent by which actual or projected sales exceed the break-even sales. It may be calculated simply as the difference between actual or projected sales and the break-even sales. However, it is best to calculate margin of safety in the form of a ratio. Thus we have the following two formulas to calculate margin of safety:
|MOS = Budgeted Sales − Break-even Sales|
|MOS = ||Budgeted Sales − Break-even Sales|
Margin of Safety can be expressed both in terms of sales units and currency units.
The margin of safety is a measure of risk. It represents the amount of drop in sales which a company can tolerate. Higher the margin of safety, the more the company can withstand fluctuations in sales. A drop in sales greater than margin of safety will cause net loss for the period.
Use the following information to calculate margin of safety:
|Sales Price per Unit||$40|
|Variable Cost per Unit||$32|
|Total Fixed Cost||$7,000|
|Breakeven Sales Units||= $7,000 ÷ ($40 - $32)||= 875|
|Budgeted Sales Units||= $40,000 ÷ $40||= 1,000|
|Margin of Safety||= (1000 − 875) ÷ 1,000||= 12.5%|