Margin of safety

Margin of safety is the gap between the sales a business actually makes, or plans to make, and its break-even level of sales. You calculate it as:

Margin of safety = actual or budgeted sales − break-even sales

It shows how much sales can fall before the business reaches break-even. A large margin gives the business a cushion: sales could drop by that amount and it would still avoid a loss. A small margin means even a slight fall in sales could push it into loss.

Worked example

A mobile pet-grooming service has break-even sales of 480 appointments a year. It budgets for 620 appointments. Margin of safety = 620 − 480 = 140 appointments. The business could lose 140 appointments and still just break even. If it lost more than 140 appointments, it would make a loss.

Below break-even

If actual or budgeted sales are below break-even sales, the business is making a loss and has no positive margin of safety. For example, break-even sales of 480 appointments and actual sales of 430 gives 430 − 480 = −50. The negative figure shows the business is 50 appointments short of break-even; it is not a safety cushion. Margin of safety is the gap above break-even, not the break-even point itself.