Describe Margin of Safety

Question

Give brief information about the term ‘Margin of Safety’?

Answer 1

Margin of Safety is the amount of sales which creates profit. In another terms, sales beyond Break Even Point are termed as Margin of Safety. It is evaluated as the dissimilarity between total sales and the break even sales. It can be articulated in monetary terms or number of units. It can be described which is illustrated below:

Margin of Safety = Sales – Break Even Sales

= Sales - {(Fixed Cost) / (P/V Ratio)}

= ((Sales * (P/V) Ratio) - Fixed Cost) / (P/V) Ratio

= (Contribution - Fixed Cost) / (P/V) Ratio

= Profit / (P/V) Ratio

The size of margin of safety is an incredibly imperative guide to the financial strength of a business. If margin of safety is huge, which points to that BEP is much below the Real sales, which mean business is in a sound condition and decline in sales will not influence the profit of the business. On another side, if margin of safety is low, any loss of sales might be a critical issue. Therefore, efforts require to be made to diminish fixed costs, variable costs or rising the selling price or sales volume to get better contribution and entire P/V Ratio.