The margin of safety (MOS) measures the gap between the actual revenue and the break even revenue.
As a business will break even at the break even revenue, the margin of safety indicates by how much the revenue must fall before the business starts to make a loss.
|Break even revenue||Margin of safety|
Using actual revenue, the margin of safety formula is as follows:
If dealing with budgets, then the actual revenue can be replaced with budgeted revenue.
The Margin of Safety Percentage
The safety margin can also be expressed as a percentage of the actual revenue giving the MOS percentage formula.
The percentage is sometimes referred to as the margin of safety ratio or MOS ratio.
As an example of the MOS calculation, suppose a business has revenue of 100,000 and the break even revenue is calculated to be 90,000, then using the formula, the safety margin is given by 100,000 – 90,000 = 10,000.
Alternatively this can be expressed as a percentage of the actual revenue giving the MOS percentage as 10,000 / 100,000 = 10%.
Above the break even revenue the business will make a profit, so in this example, the revenue can fall by 10,000 or 10% before the business starts to make a loss.
The same process can be applied using units instead of revenue, if in the above example, the unit selling price was 50.00, then the actual units are 100,000/50 = 2,000, and the beak even units are 90,000 / 50 = 1,800. The safety margin in units is then 2,000-1,800 = 200 units or expressed as a MOS percentage 200 / 2,000 = 10%.
About the Author
Chartered accountant Michael Brown is the founder and CEO of Double Entry Bookkeeping. He has worked as an accountant and consultant for more than 25 years in all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a BSc from Loughborough University.