Last editedMay 20222 min read
The goal of any business is to maximize profit, and two terms you’re likely to come across in cost accounting are the break-even point and margin of safety. How do these terms relate to one another, and are they relevant to your business? Here’s a closer look at the similarities, differences, and uses of break-even point vs. margin of safety in accounting.
What is the break-even point (BEP)?
We’ll start with the break-even point, or BEP. This term measures the point where a business covers all fixed and variable costs with its sales revenue. It’s the total volume of sales you’d have to make to “break even” and pay off all associated costs. At the break-even point, a business wouldn’t recognize any profit or loss; both sides are equal. Any earnings generated past this point would qualify as profit. By contrast, if the business’s sales fall below the break-even point, it would be operating at a loss.
To calculate the BEP, you can use the following formula:
For example, imagine that a mattress company has fixed costs of $150,000. They sell a mattress for $250, which costs $100 in variable costs per unit. To work out the break-even point, you can use the formula above:
The company must sell 1,000 to cover all fixed and variable costs. This is the break-even point.
What is the margin of safety (MOS)?
The margin of safety uses the break-even point as its basis, measuring the margin between actual or forecasted sales and break-even point. Here’s what this looks like in a formula:
Let’s look at the mattress company above, which we’ve determined to have a break-even point at 1,000 mattress sales. The company forecasts that it will sell 1,400 mattresses in the next accounting period. This leaves a margin of safety at (1400 – 1000) or 400 mattresses. The company can sell fewer mattresses than 400 and still earn profit, giving it some room to breathe.
Break-even point vs. margin of safety: similarities
There are several factors that break-even point and margin of safety have in common.
Both use the break-even analysis as a starting point.
Both measures use a company’s sales volumes, selling prices, units, and costs as variables.
Both can be used to make future decisions for the business.
For example, if the margin of safety is too low, a business owner might decide not to continue with the current production plan. It might be necessary to increase the product’s per-unit price to widen this margin.
Break-even point vs. margin of safety: differences
While there are numerous similarities, it’s also important to recognize the differences between these two metrics.
Margin of safety measures the difference between real and break-even sales. Break-even point measures the volume of sales where all costs are covered.
Both figures examine risk, but break-even point only goes as far as determining where the risk level is zero. Margin of safety takes this measurement a step further to assess business risk.
Ultimately, both concepts are important when analyzing cost, value, and production. They can be used together to make important business decisions using current and forecasted sales figures. Both give business owners a better idea of the sales volumes required to cover both fixed and variable costs, as well as how much room there is left to maneuver. The higher the margin of safety, the more space the company has to change tactics before losses are incurred.
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