Managerial Accounting: How to Determine Margin of Safety
In managerial accounting, margin of safety is the difference between your actual or expected profitability and the break-even point. It measures how much breathing room you have — how much you can afford to lose in sales before your net income drops to zero. When budgeting, compute the margin of safety as the difference between budgeted sales and the break-even point. Doing so will help you understand the likelihood of incurring a loss.
Use a graph to depict margin of safety
The graph shows you how to visualize margin of safety. In this example, margin of safety is the difference between current or projected sales volume (60 units) and break-even sales volume (34 units), or 26 units. Sales would have to drop by 26 units for existing net income of $240 to completely dry up.
Use formulas to determine the margin of safety
To compute margin of safety directly, without drawing pictures, first calculate the break-even point and then subtract it from actual or projected sales. You can use dollars or units:
Margin of safety (in dollars) = SalesActual – SalesBE
Margin of safety (in units) = Unit salesActual – Unit salesBE
You can compute margin of safety either in sales dollars or in units, but be consistent. Don’t subtract break-even sales in units from actual sales in dollars!