What is the purpose of the margin of safety and what types of situations would you...

What is the purpose of the margin of safety and what types of situations would you use the margin of safety?

Expert Solution

The margin of safety refers to the sales of a company over and above the break even point. The break even point is the sale at which the company makes neither profits nor losses.In other words, it refers to the " safety net" of the company i.e. the amount of sales a company can lose before it starts making a loss. The margin of safety is extremely important to assess the company's profitability. The higher the margin of safety, the more profitable is the company.

The type of situations in which the margin of safety can be used are as follows:

-When an accountant wants to know how safe it is to sell the product, the margin of safety analysis shall be used. For example, the company's break even sales are 100 units and the sales are 101 units, then it is quite unsafe to sell the product as if the sales drop by even 2 units, the company shall start incurring a loss.

-It can be used when the company has to decide whether to leave the market or manufacture the product. If the margin of safety is very low, it is prudent to leave the market.

ekkarill92 answered 1 year ago

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What is the purpose of the margin of safety and what types of situations would you...

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