Definition
The margin of safety is the amount by which actual or budgeted sales exceed break-even sales, expressed in units, in revenue or as a percentage of sales. It shows how far sales can fall before the business starts making a loss, which makes it a quick measure of operating risk for a budget, a product or a new location.
How it works
A margin of safety of 40% means sales could drop by 40% and the business would still break even. A margin of 5% means a single weak month erases the profit. Compare the margin with how much sales have actually varied in the past: if monthly sales often swing by 20%, a 15% margin is thin.
The margin of safety ratio is the inverse of the degree of operating leverage at the same sales level. A business with a 25% margin of safety has an operating leverage of 4: a 10% change in sales moves profit by about 40%.
Raise the margin by lowering break-even (cutting fixed costs or raising unit contribution) or by growing sales. The break-even calculator shows it alongside break-even when you enter expected sales.
Formula
Margin of safety = Expected sales - Break-even sales
Margin of safety % = (Expected sales - Break-even sales) ÷ Expected sales
Degree of operating leverage = 1 ÷ Margin of safety %
Example: budgeted sales of 120,000
Break-even sales are 75,000 and budgeted sales are 120,000. The margin of safety is 45,000, or 37.5% of sales. Operating leverage is 1 ÷ 0.375 = 2.67, so a 10% fall in sales would cut profit by about 26.7%.