Learning Materials For Accounting, Management , Finance And Economics.

Sunday, October 2, 2011

Concept Of The Margin Of Safety (M/S)

The margin of safety(M/S) is the excess of budgeted (or actual) sales over the break-even sales. Margin of safety states where losses begin if the sales drop. Margin of safety = Budgeted sales- Break-even sales. The higher the margin of safety, the safer the position of the business.
A margin of safety ratio is the percentage of margin of safety to the budgeted sales.

Margin of safety ratio(in %) = (Budgeted sales - Break-even sales)/Budgeted sales
Break-even ratio = 100% - Margin of safety ratio
There exists a close relationship between the margin of safety and the net profits.
Net profits before tax = (Budgeted sales - Break-even sales) X P/V ratio
= Margin of safety X P/V ratio

Therefore, P/V ratio = Net profits before tax/Margin of safety