The margin of safety is the number of units which are expected to be sold above break-even.
The margin of safety is often expressed as a percentage.
If you want to think of the margin of safety in an equation format, it can be represented as follows:
Margin of Safety= Expected Sales – Breakeven Sales
The sales figure can be expressed in units or monetary terms.
For example, if the break-even output level is 10,000 units and a business currently sells 12,000 units, then the margin of safety is 2,000 units. It can also be expressed in terms of sales revenue.
Margin of Safety = 12,000 – 10,000 = 2,000
While it is a relatively crude measure, the margin of safety can be used by managers as a rule-of-thumb to ensure sales are not lost to the degree that the business fails to breakeven.
If the margin of safety is quite high, then costs can increase or prices decrease considerably before remedial action might be required.
If the margin of safety is quite low, then a greater emphasis might need to place on keeping costs and prices under control.