Last editedMay 20222 min read
In accounting, the margin of safety and profit are both important calculations to be aware of. While both use revenue in their calculations, the outcome and intent of these two figures are different. Profit measures a business’s earnings and margin of safety measures the sales required to turn a profit. We’ll cover the differences between margin of safety vs. profit below, as well as how to use the margin of safety profit formula.
What is margin of safety?
Margin of safety, or MOS, is a measure of the difference between the break-even point and real-life sales. A business must meet a certain threshold of sales to cover all fixed and variable costs, called the break-even point (BEP). Margin of safety measures the amount above the BEP, showing revenue earned after all required expenses have been paid. Another way to look at it is the distance a business is from being unprofitable.
The higher your margin of safety, the bigger the cushion your business has. This figure can also be used to determine whether a product is worth selling. For example, if you must sell 3,500 items to break even and your projected sales are only 3,700 items, your margin of safety is only the profit earned from 200 items. This may or may not be worth the investment, depending on the product’s cost of production.
How to calculate margin of safety ratio
You’ll need to know two key figures for the margin of safety profit formula:
Actual sales (real or projected)
Break-even point (in sales)
Once you’ve determined these figures, here’s how to calculate margin of safety ratio:
Margin of Safety = Actual Sales – Break-Even Sales
For example, imagine that a business’s BEP is 500 products, and it has sold 1000 products. The margin of safety would be (1000 – 500) or 500 products. It is making a profit on the 500 items above the break-even point.
What is profit?
While margin of safety looks at the sales above a business’s break-even point, profit looks at the financial breakdown of these sales. It measures the revenue generated from any business activity, including sales as well as investments, interest, and other earnings.
When written as a formula, profit is calculated as:
Profit = Total Revenue – Total Expenses
However, this can be further broken down to gross profit, net profit, and operating profit, each of which looks at the equation in a slightly different way. Gross profit measures revenue earned after subtracting production-related costs, while net profit measures revenue earned after all costs have been deducted.
Margin of safety vs. profit: key differences
While the margin of safety and profit are closely related, there are a few key differences to keep in mind.
Purpose: Margin of safety shows the percentage that sales can drop before a business is operating at a loss. Profit simply shows how much loss or income was generated during the accounting period, irrespective of break-even point.
Timeframe: Profit (or loss) is calculated using revenue and expense accounts on the income statement from the past accounting period. Margin of safety is often calculated using forecasted sales figures to anticipate future fluctuations.
Management: A company’s managers are most interested in margin of safety, which can be used to guide the decision-making process. By contrast, profit is looked at not only by management, but also by outside parties including the IRS, investors, and others with a vested financial interest.
Profit margin is more closely related to margin of safety than simple profit. Both the profit margin and margin of safety can be used in a similar fashion to guide important financial decisions for the business, fueling growth.
We can help
GoCardless helps you automate payment collection, cutting down on the amount of admin your team needs to deal with when chasing invoices. Find out how GoCardless can help you with ad hoc payments or recurring payments.