Lessons · Accounting · the margin of safety
The margin of safety
How far sales can fall before the business stops making a profit: current sales minus break-even sales, often given as a percentage of current sales.
Hone is a place to practise a career, one idea a day. This is one of its lessons, written out in full and free to read without an account.
Not yet checked by a qualified accountant. This lesson was written for Hone. Practice material, not professional advice. What that means.
What it is for
It turns two numbers a board already has into a statement about risk. Two businesses can make the same profit while one of them is 5% away from a loss and the other is 40% away, and the profit figure alone will never say which is which.
How to think about it
Work out break-even in the same units as your sales figure. Subtract it from current sales. Divide by current sales for the percentage.
Worked example
Break-even 3,000 units at 25.00 = 75,000 of salesBreak-even expressed in money, to match.
Current sales 100,000Where the business is now.
Margin of safety = 100,000 − 75,000 = 25,000The room before a loss.
As a percentage = 25,000 / 100,000 = 25%A quarter of revenue could go before profit does.
Your turn
Sales 100,000 and break-even 75,000. Write the line that gives the percentage.
Margin of safety = 25,000 / = 25%
Solve one, graded on the server
The trap
Dividing by break-even sales instead of current sales. It gives 33% here rather than 25%, and it flatters the business at exactly the moment somebody is relying on the figure to judge risk.