Margin of Safety (MOS):
Contents:

Definition of
Margin of Safety (MOS)

Formula of MOS

Example

Review Problem
The
excess of actual or budgeted sales over the break
even volume of sales is called margin of safety.
At break even point costs are equal to sales revenue
and profit is zero. Margin of safety, therefore,
tells us the amount of sales that can be dropped
before losses begin to be incurred. With a high
margin of safety business have low risk of not
breaking even and with a low margin of safety
business have high risk of not breaking even.
The formula or
equation for the calculation of margin of safety is
as follows:
Margin of Safety = Total budgeted or actual sales −
Break even sales 
Margin of Safety Ratio:
The
margin of safety can also be expressed in percentage
form (Margin of safety ratio). This
percentage is obtained by dividing the margin of
safety in dollar terms by total sales. Following
equation is used for this purpose.
Margin of Safety = Margin of safety in dollars /
Total budgeted or actual sales
Sales(400
units @ $250) 
$100,000 
Break even
sales 
$87,500 
Calculate margin of safety. 
Calculation:

Sales(400units
@$250) 
$100,000 
Break even
sales 
$ 87,500 


Margin of
safety in dollars 
$ 12,500 


Margin of
safety as a percentage of sales:
12,500 /
100,000
= 12.5% 
It
means that at the current level of sales and with
the company's current prices and cost structure, a
reduction in sales of $12,500, or 12.5%, would
result in just breaking even. In a single product
firm, the margin of safety can also be expressed in
terms of the number of units sold by dividing the
margin of safety in dollars by the selling price per
unit. In this case, the margin of safety is 50 units
($12,500 ÷ $ 250 units = 50 units).
Voltar
company manufactures and sells a telephone answering
machine. The company's contribution margin income
statement for the most recent year is given below:
Description 
Total 
Per
unit 
Percent of Sales 
Sales
(20,000 units) 
$
1,200,000 
$60 
100% 
Less
variable expenses 
900,000 
$45 
?% 




Contribution margin 
300,000 
$15 
?% 
Less
fixed expenses 
240,000 






Net
operating income 
60,000 







Required:
margin of safety both in dollars and percentage
form.
Solution to Review Problem:
Margin of
safety = Total sales – Break even sales*
= $1,200,000
– $960,000
= $240,000
Margin of
safety percentage (Margin of safety ratio) =
Margin of safety in dollars / Total sales
= $240,000 /
$1,200,000
= 20%
*The break even
sales have been calculated as follows:
Sales =
Variable expenses + Fixed expenses + Profit
$60Q = $45Q +
$240,000 + $0**
$15Q =
$240,000
Q = $240,000 /
$15 per unit
Q = 16,000
units; or at $60 per unit. $960,000
**We know that
break even is the level of sales where
profit is zero. 
Case Study (A Real
Business Example):
Pak Melwani
and Kumar Hathiramani, former silk merchants
from Bombay, opened a soup store in
Manhattan after watching a Seinfeld episode
featuring the "soup Nazi." The episode
parodied a real life soup vendor. Ali
Yeganeh, whose loyal customers put up with
hourlong lines and "snarling customer
service." Melwani and Hathiramani approached
Yeganeh about turning his soup kitchen into
a chain, but they were gruffly rebuffed.
Instead of giving up, the two hired a French
chef with a repertoire of 500 soups and
opened a store called Soup Nutsy. For $6 per
serving, Soup Nutsy offers 12 homemade soups
each day, such as sherry crab bisque and
Thai coconut shrimp. Melwani and Hathiramani
report that in their first year of
operation, they netted $210,000 on sales of
$700,000. They report that it costs about $2
per serving to make the soup. So their
variable expenses ratio is onethird ($2
cost / 6$ selling price). If so, what are
their fixed expenses? We can answer that
question using the equation approach as
follows:
Sales =
Variable expenses + Fixed expenses + Profits
$700,000 =
(1/3) × 700,000 + Fixed expenses + $210,000
Fixed expenses
= $700,000 – (1/3 of $700,000) – $210,000
= $256,667
With this
information we can determine that the break
even point is about $385,000 of sales. This
gives the store a comfortable margin of
safety of 45%.
Source: Silva Sansoni, "The Starbucks of
Soup?" Forbes, July7, 19997, pp.9091.

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