Question

Select an article of your choice from the library on cost-volume-profit, margin of safety, or the degree of operating leverage and provide an analysis of what you found interesting, challenges that the company might face, and how this knowledge could affect managerial decision making.

Answer 1

Analysis

In accounting parlance, margin of safety is the difference between the expected (or actual) sales level and the breakeven sales level. It can be expressed in the equation form as follows:

Margin of Safety = Expected (or) Actual Sales Level (quantity or dollar amount) - Breakeven sales Level (quantity or dollar amount)

Challenge

The measure is especially 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 may be canceled. Higher the margin of safety, the more the company can withstand fluctuations in sales. A drop in sales greater than margin of safety will cause net loss for the period.

Management Decision

Using margin of safety, Management can decide that whether it is worth to invest in particular project. Project with low P/B Ratio should be ignored. The margin of safety helps in protecting from poor decisions. Because actual cost of project is difficult to compute accurately, the margin of safety helps in investment decision.

Example

Use the following information to calculate margin of safety:

Sales Price per Unit	$40
Variable Cost per Unit	$32
Total Fixed Cost	$7,000
Budgeted Sales	$40,000

Solution

Breakeven Sales Units	= $7,000 ÷ ($40 - $32)	= 875
Budgeted Sales Units	= $40,000 ÷ $40	= 1,000
Margin of Safety	= (1000 ? 875) ÷ 1,000	= 12.5%