Margin of Safety (MOS):

Learning Objectives:

1. Define and explain margin of safety.

2. Calculate margin of safety ratio.
3. What is its significance/importance?

Contents:

1. Definition of Margin of Safety (MOS)

2. Formula of MOS
3. Example
4. Review Problem

Definition and Explanation:

Margin of safety (MOS) is the excess of budgeted

or actual sales over the break even volume of sales.
It stats the amount by which sales can drop before
losses begin to be incurred. The higher the margin of
safety, the lower the risk of not breaking even.

Formula of Margin of Safety:

The formula or equation for the calculation of margin

of safety is as follows:

[Margin of Safety = Total budgeted or actual

sales − Break even sales]

The margin of safety can also be expressed in

percentage form. This percentage is obtained by
dividing the margin of safety in dollar terms by total
sales. Following equation is used for this purpose.
 [Margin of Safety = Margin of safety in
dollars / Total budgeted or actual sales]

Example:

Sales(400 units @ $250) $100,000

Break even sales $87,500
Calculate margin of safety

Calculation:
Sales(400units @$250) $100,000
Break even sales $ 87,500
---------
Margin of safety in dollars $ 12,500
=======
Margin of safety as a percentage of sales:

12,500 / 100,000

= 12.5%

It means that at the current level of sales and with

the company's current prices and cost structure, a
reduction in sales of $12,500, or 12.5%, would result
in just breaking even. In a single product firm, the
margin of safety can also be expressed in terms of
the number of units sold by dividing the margin of
safety in dollars by the selling price per unit. In this
case, the margin of safety is 50 units ($12,500 ÷ $
250 units = 50 units).

Review Problem:
Voltar company manufactures and sells a telephone
answering machine. The company's contribution
margin income statement for the most recent year is
given below:

Percent
Description Total Per unit
of Sales
Sales (20,000 $
$60 100%
units) 1,200,000
Less variable
900,000 $45 ?%
expenses
--------- -------- --------
Contribution
300,000 $15 ?%
margin
Less fixed
240,000 ====== =====
expenses
---------
Net operating
60,000
income
======

Required: margin of safety of safety both in dollars

and percentage form.

Solution to Review Problem:

Margin of safety = Total sales – Break even

sales*

= $1,200,000 – $960,000

= $240,000
Margin of safety percentage = Margin of safety
in dollars / Total sales

= $240,000 / $1,200,000

= 20%

*The break even sales have been calculated as

follows:

Sales = Variable expenses + Fixed expenses +

Profit

$60Q = $45Q + $240,000 + $0**

$15Q = $240,000

Q = $240,000 / $15 per unit

Q = 16,000 units; or at $60 per unit. $960,000