Margin of Safety is a term every small business owner must learn and understand.
Margin of safety(MOS) is the amount by which your budgeted or actual revenue has to drop before you reach your breakeven point.
In the other word, it is the excess of budgeted or actual sales over the break even sales figure. To calculate Margin of Safety, you will subtract the breakeven sales from the actual sales or budgeted sales. It depends on the figure you are working with. Then you divide the result by the actual sales or budgeted sales. That is:
Margin of Safety = Sales – Breakeven Sales
The difference between Sales and Breakeven Sales is the margin of safety in term of Naira. To express your margin of safety in percentage, the formula becomes:
Margin of Safety = (Sales – Breakeven Sales)/Sales x 100
But if you want to know your MOS in term of the number of units of item you sell, the formula to be used will be as follows:
Margin of Safety = (Sales – Breakeven Sales) /Selling Price per unit.
This formular only applies if the company sells only one product.
Let’s refer to our examples on how to calculate Breakeven Point where we calculated BEP Sales(N) as N750,000 and BEP quantity (Units) as 50 units. Remember that our selling price is N15,000.
Supposing your sales or budgeted sales is N1,050,000
- Your MOS will be (N1,050,000 – N750,000) = N300,000
This means that your revenue will have to drop by N300,000 before you reach your Breakeven Point where you neither make gain nor loss.
- If you want to express it in percentage,
the formular will be: (N1,050,000 – N750,000)/N1,050,000 x 100 = 28.57%
- In case you want to determine your margin of safety in units, simply divide your margin of safety in (i) above by the selling price.
N300,000/N15,000 = 20 units
This implies that your sales has to drop by 20 units before your come down to your breakeven point.
Significance of Margin of safety(MOS)
The significance of MOS is that it helps the company to know how far sales could drop before the company would have a net loss. It is usually as a percentage of your actual revenue or budgeted revenue as the case may be. The greater the percentage, the safer for the company. If you have a very high MOS, this means that if there is unexpected fall in your revenue which may be due to loss of contract or customer, the company can easily weather the storm. But if your MOS is very low, it means that any loss of anticipated contract or revenue source may spell a doom to the business. Since projection is subject to probability, that is, there is no guarantee or assurance that you will meet your projection, businesses that promise a very high Margin of Safety will surely be more attractive to investors or lenders.
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