Description: This is the amount by which sales can drop before a company’s breakeven point is reached. It is particularly useful in situations where large portions of a company’s sales are at risk, such as when they are tied up in a single customer contract that can be cancelled. Knowing the margin of safety gives an analyst a good idea of the probability that a company may find itself in difficult financial circumstances caused by sales fluctuations.
Formula: Subtract the breakeven point from the current sales level, and then divide the result by the current sales level. To calculate the breakeven point, divide the gross margin percentage into total fixed costs. This formula can be broken down into individual product lines for a better view of risk levels within business units. The formula is as follows:
Current Sales Level – Breakeven Point
Current Sales Level
Cautions: This calculation is not of much use in cases where strong seasonal swings in sales will send the margin soaring far above and plummeting well below the breakeven point on a monthly basis.