Breakeven Point vs Margin of Safety
Difference between breakeven point and margin of safety is a necessary knowledge to have as Breakeven Point (BEP) and Margin of Safety (MOS) are two concepts that carry a significant importance in decision making under cost accounting. Both of these concepts deal with costs, sales volumes, selling prices and number of production units and generate imperative information to for the management to decide upon the level of production, selling prices of the items produced. Breakeven point is the sales volume at which the business organization does not earn any profit. Correspondingly, margin of safety is the degree at which the actual sales exceed the breakeven sales, that is usually calculated as a ratio.
What is Breakeven Point?
Breakeven point is the most vital figure that comes under breakeven (Cost-Volume-Profit)analysis. It is the sales volume at which a business covers all costs (both fixed costs and variable) from the sales revenue that earns. Therefore, at the breakeven point zero profit is recorded. Breakeven point can be calculated as follows.
BEP (in units) = Total Fixed Costs / Contribution per Unit
Where, Contribution per Unit = Selling Price per Unit – Variable Cost per Unit
There is an alternative way to calculate BEP that can be illustrated as follows.
BEP (in dollars) = Total Fixed Cost / Average Contribution Margin per unit
The figure calculated using above formulas depicts the point where the business earns no profits, no losses situation. Therefore, all the units that sell after this breakeven point generate profits for the business. BEP is important for an organization due to following reasons.
• BEP determines the maximum amount of profits that can be generated by a business.
• BEP determines the changes in profitability to the changes in cost and selling price figures.
• BEP helps management to make decisions about altering, adding and removing fixed and variable costs.
What is Margin of Safety?
This is an important concept comes under breakeven analysis. This can simply be defined as the difference between actual sales and breakeven sales. This is usually calculated in a ratio form and is determined via following two formulas.
MOS = Budgeted Sales – Breakeven Sales
MOS = (Budgeted Sales – Breakeven Sales) / Budgeted Sales
Margin of Safety ratio measures the risk of a business. Therefore, by knowing the level of risk that an organization has to face through Margin of Safety, the management can make necessary adjustments to the selling prices and can make the situation changed.
See the following example.
P (Selling price) = $15
V (Variable Cost) = $ 7
Total Fixed Cost for the Year – $ 9,00
Production Capacity of the Plant = 2000 Units]
So;
BEP (in Units) = 9000 / (15 – 7) = 1,125
BEP (in Dollars) = 1,125 * 15 = $16,875
Margin of Safety = 2000 – 1125 = 875 Unit
What are the similarities between Break-even Point and Margin of Safety?
• Both concepts are derived from the same phenomenon, the break-even analysis.
• Both concepts deal with costs, sales volumes, selling prices and number of production units.
• Both are future sighted i.e. help management to make selling and pricing decisions.
What is the difference between Break-even Point and Margin of Safety?
• Breakeven point is the sales volume at which a business covers all costs. Margin of safety is the difference between actual sales and breakeven sales.
• Breakeven point measures the point where the risk is zero. Margin of safety measures the risk of a business.
• Breakeven point is calculated as units as well as selling price basis. Margin of safety is usually calculated as a ratio on unit basis.
Summary:
Break-even Point vs Margin of Safety (BEP vs MOS)
Breakeven Point and Margin of Safety are two important concepts that come under CVP analysis. BEP describes the sales amount where the business earns zero level of profits. On the other hand, MOS determines the amount of profits that the business can assure at a point after the breakeven point. Therefore, these two measures provide a significant help to the management of business entities, to make their decisions on the amount of selling units, cost controlling, determining selling prices, etc.