Margin of Safety
Margin of safety is the difference between the actual sales and the sales at the break even point or, the excess of actual sales over the break even sales. At BEP, the margin of safety is nil because the actual sales and the break even sales are equal. Margin of safety is the excess of actual production over the production at the break even point because of marginal costing assumption that the production or output must coincide with the sales.
Margin of safety can also be expressed in percentage. The formula for calculating the margin of safety is,
| Margin of safety |
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Actual Sales - Break Even Sales |
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| Margin of safety |
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| Margin of safety |
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| Margin of Safety (in percentage) |
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Margin of safety measures the soundness of the business. When the margin of safety is high, it indicates the concern's strength and a low margin of safety indicates the weakness of the concern. So in order to earn more profits, efforts should be made by the management to increase the margin of safety. The following steps increase or improve the margin of safety:
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Increase the level of production or selling price or both.
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Reduce the fixed cost or variable cost or both.
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Substitute the existing unprofitable product with profitable products.
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Change the sales mix in order to increase the contribution.
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