The Margin of Safety is a measure or Key Performance Indicator (KPI) 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
Your Breakeven point is calculated as follows:
Fixed Expenses / (Revenue – COGS) / Revenue
The breakeven point is essentially the amount of sales you need to generate to make 0 loss or 0 profit.
The Margin of Safety demonstrates the buffer that your business has as a percentage. If you have a sales pattern that varies from month to month an average would be best used.
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.
There for your Margin of Safety is
($750,000 - $525,000) / $750,000 = 30%,
i.e. your sale 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.
