What is margin of safety and how is it calculated?
Margin of safety is a concept related to breakeven analysis. Basically, it helps a company and its management team understand the difference between total sales and breakeven sales. Breakeven sales is essentially the amount of sales needed to generate enough gross profit to cover the company’s fixed costs.
A low margin of safety means that total sales barely exceeds breakeven sales. This is a big risk for the company because if total sales fall to the breakeven level or even below breakeven, that may result in the company have a hard time covering their fixed costs.
Margin of safety can be expressed in dollar or in percentage form:
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