Definition: The margin of safety is the amount of sales over a company’s break-even point. In other words, the margin of safety is the amount of sales a company can lose before it actually starts to lose money or stops making a profit.
What Does Margin of Safety Mean?
Managerial accountants analyze production processes and market demand to estimate how much of a product they will be able to sell in a period. Based on these calculations, the produces products.
The breakeven point for a production process is when the sales income from the goods produced equals the actual cost of producing the products. This is where the company breaks even and doesn’t actually make a profit.
The margin of safety is also an important figure because it shows how safe the business is in producing products. For example, assume a manufacturer calculates its breakeven to be 100 units. Based on its sales projections, the company anticipates selling 150 units during the next quarter. The margin of safety on this product is 50 units.
This means that the company could potentially lose 50 sales during the period without creating a loss from operations. If the company loses 60 sales during the period, it won’t make its breakeven point and will actually lose money producing the product. The margin of safety calculation helps management assess the risk of producing a produce and aids in the overall decision to manufacture to product or leave the market.