Margin of Safety Calculator
Margin of safety calculator helps you determine the number of sales that surpass a business' breakeven point. The breakeven point (also known as breakeven sales) is the point where total costs (expenses) and total sales (revenue) are equal or "even". That is, there is no net loss or gain.
The term 'margin of safety' is used in accounting and investing in referring to the extent to which business, project, or an investment is safe from losses. This article provides a detailed description of how to calculate the margin of safety and arrive at the margin of safety ratio, the margin of safety percentage, and margin of safety sales in dollars and units.
And it provides examples of how to use the margin of safety calculator to quickly determine how much decrease in sales a company can accommodate before it becomes unprofitable.
What is margin of safety?
The margin of safety is the difference between the current or estimated sales and the breakeven point.
The term 'margin of safety' was initially coined by the investors, Benjamin Graham and David Dodd, to refer to the gap between an investment's intrinsic value and its market value. An asset or security's intrinsic value is the value or price an investor believes to be the "real or true worth" of that asset, independent of what others (the market) think. But this value varies between investors because they use different metrics to estimate it. Investors try to buy assets at a price lower than their intrinsic value so that they can cushion against future losses from possible errors in their estimations.
Similarly, in the breakeven analysis of accounting, the margin of safety calculation helps to determine how much output or sales level can fall before a business begins to record losses. Hence, managers use the margin of safety to make adjustments and provide leeway in their financial estimates. That way, the company can incur unforeseen expenses or losses without a significant impact on profitability.
A low margin of safety signals a high risk of loss, while a high margin of safety means that the business or investment can withstand crises. The goal is to be safe from risks or losses, that is, to stay above the intrinsic value or breakeven point.
How to calculate the margin of safety? Margin of safety formulas
You can calculate the margin of safety by deducting the breakeven point from the current or estimated sales. There are different ways to express the margin of safety: as a ratio or percentage or as sales in monetary terms or units to still break even (you can read about it in the break even calculator).
Now that you know what a margin of safety is, let's explore the margin of safety formula:
- Margin of safety in dollars
margin of safety = current (estimated) sales – breakeven point
- Margin of safety ratio
margin of safety (ratio) = current (estimated) sales – breakeven point / current (estimated) sales
- Margin of safety percentage
margin of safety (%) = [current (estimated) sales – breakeven point / current (estimated) sales] * 100
- Margin of safety in units
margin of safety (units) = current (estimated) sales – breakeven point / sales price per unit
Margin of safety examples
Example 1: simple calculation of margin of safety with current or estimated sales and breakeven sales
If Baggies Enterprise's sales for October 2020 is $80,000, and the breakeven sales is $50,000. The margin of safety is calculated as follows:
margin of safety in dollars = $80,000 - $50,000 = $30,000
margin of safety ratio = 80,000 - 50,000 / 80,000 = 0.375
margin of safety percentage = 37.5%
Example 2: computation of margin of safety with sales volume, selling price and cost price per unit (advanced mode)
Let's consider the new Google Pixel 4a phone. Assuming Google intends to produce 500,000 units at the cost of $300 per unit to sell at $400, we could calculate the margin of safety as a ratio or percentage, and in both dollar and unit sales.
First of all, we collect the data provided
- sales volume =
- selling price per unit =
- selling price per unit =
- cost price per unit =
- sales volume =
Determine the current or estimated sales
Current or estimated sales = sales volume x selling price per unit
= 500,000 * $400 = $200,000,000
- Determine the breakeven sales
Breakeven sales = sales volume * cost price per unit
= 500,000 * $300 = $150,000,000
- Margin of safety calculation
Margin of safety = $200,000,000 – $150,000,000 = $50,000,000
Margin of safety ratio = $200,000,000 – $150,000,000 / $200,000,000 = 0.25
Margin of safety percentage = [$200,000,000 – $150,000,000 / $200,000,000] * 100 = 25%
Margin of safety (units) = $50,000,000 / $400 = 125,000
The values obtained from the margin of safety calculations mean that Google's revenue from the sales of the Pixel 4a can fall by $50,000,000 or 25%, which is 125,000 units without incurring any losses.
That means revenue from the sale of 375,000 units is enough to cover the entire production cost.
Suppose the management decides that this is not an acceptable safety margin. In that case, Google can choose to:
- Improve the contribution margin by removing the water-resistance feature, consequently reducing the unit cost of production to
- Improve their profitability by increasing the production volume to
- Adopt a more profitable product mix by releasing an expensive Pixel 4a 5G with the water-resistant feature while selling the Pixel 4a at a lower price of
Now, calculate the new margin of safety using our calculator. [Hint: It is almost double the previous margin!]
Financial forecasts adjustments like this make the margin of safety calculator necessary.