Your Break Even Point and your Margin of Safety are two measurements that a business should know.

You will need to calculate your Break Even Point before you calculate your Margin of Safety.

Break Even Point

Your Break Even Point is essentially:

1. The point of zero profit and loss, i.e., where the revenue equals the costs; or
2. The amount of money you are required to earn (your sales) that will cover all your out goings.

Your Break Even Point can be calculated as follows:

Fixed Expenses / ((Revenue – Cost Of Goods Sold) / Revenue)

Revenue less Cost of Goods Sold will also calculate your Contribution Margin.  The total Contribution Margin will show how much a business has to contribute to its fixed costs.

Margin of Safety

The Margin of Safety is a measure of how far your sales can fall before reaching your breakeven point. It is a measure of risk, stating (as a percentage) how many sales you can afford to lose before you start make a loss.

It is calculated as follows:

(Current Sales level – Breakeven Point) / Current Sales level

The Margin of Safety demonstrates the buffer that your business has.  If you have a sales pattern that varies from month to month an average is best utilised.

Example of Margin of Safety calculation:

Sales                                   $750,000

COS / COGS                        $450,000

Fixed Expenses                   $210,000

Profit                                    $90,000

Break Even Point $210,000 / ($750,000 – $450,000) / $750,000

= $525,000

Therefore, once your sales fall below $525,000 you will start to lose money.

Therefore your Margin of Safety is:

($750,000 - $525,000) / $750,000

= 30%, i.e. your sales could drop by 30% before you start to lose money.

If you would like to discuss further please contact us:
 McNamara and Co - Chartered Accountants, located minutes from the Melbourne CBD
 www.mcnamaraandcompany.com.au/contact-us
 Phone +61 3 9428 1062
 Email admin@mcnamaraandco.com

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