Your Break Even Point and your Margin of Safety are two measurements that a business should know.
You will need to calculate your Break Even Point before you calculate your Margin of Safety.
Break Even Point
Your Break Even Point is essentially:
- The point of zero profit and loss, i.e., where the revenue equals the costs; or
- The amount of money you are required to earn (your sales) that will cover all your out goings.
Your Break Even Point can be calculated as follows:
Fixed Expenses / ((Revenue – Cost Of Goods Sold) / Revenue)
Revenue less Cost of Goods Sold will also calculate your Contribution Margin. The total Contribution Margin will show how much a business has to contribute to its fixed costs.
Margin of Safety
The Margin of Safety is a measure of how far your sales can fall before reaching your breakeven point. It is a measure of risk, stating (as a percentage) how many sales you can afford to lose before you start make a loss.
It is calculated as follows:
(Current Sales level – Breakeven Point) / Current Sales level
The Margin of Safety demonstrates the buffer that your business has. If you have a sales pattern that varies from month to month an average is best utilised.
Example of Margin of Safety calculation:
Sales $750,000
COS / COGS $450,000
Fixed Expenses $210,000
Profit $90,000
Break Even Point $210,000 / ($750,000 – $450,000) / $750,000
= $525,000
Therefore, once your sales fall below $525,000 you will start to lose money.
Therefore your Margin of Safety is:
($750,000 - $525,000) / $750,000
= 30%, i.e. your sales could drop by 30% before you start to lose money.
If you would like to discuss further please contact us:
McNamara and Co - Chartered Accountants, located minutes from the Melbourne CBD
www.mcnamaraandcompany.com.au/contact-us
Phone +61 3 9428 1062
Email admin@mcnamaraandco.com
Please refer to disclaimer at the bottom of the page.
