Vareto Finance Glossary
Margin Of Safety
Margin of safety is the difference between a company’s expected profitability and its break-even point. It is calculated as (current sales - breakeven point) / current sales.It highlights the risk of loss that a business may be exposed to as a result of any changes in sales. The calculation is especially useful when a company is likely to face a significant decline or elimination in sales, especially when a sales contract is about to end. By checking the minimum margin of safety, companies can take action for cutting down costs. If the margin of safety is high, it means the business won't be majorly impacted by sales variations.
For example, if a SaaS company earns $200,000 in sales and its break-even point is $100,000, the margin of safety will be (200,000 - 100,000) / 200,000 = 0.5To express the margin of safety as a percentage, the result can be multiplied by 100 = 0.5*100 = 50%
Why it matters
As part of the budgeting exercise, the margin of safety is the net change between a company’s sales and the estimated decline in sales before it turns zero. Calculating the margin of safety alerts company management about the potential risk of loss that may occur. A lower margin of safety requires company management to cut down on expenditure. A high margin of safety can act as an assurance about sufficient protection against sales variations.A low margin of safety may require the following measures by company management to ensure an improvement:A. Raise the product/service selling priceB. Cut down on fixed or variable expensesC. Boost product/service delivery volumes D. Cut down or stop focusing on unprofitable products/services
See Vareto in action
Give your finance team the tools needed to launch your company into the future.