From the following particulars, calculate the Margin of Safety:
Fixed cost Rs. 1,00,000
Variable cost Rs. 1,50,000
Total Sales Rs. 3,00,000
Answer (2)
To calculate the Margin of Safety, we first need to understand that it represents the difference between actual sales and break-even sales. It shows the amount by which sales can drop before a business reaches its break-even point, where total costs equal total sales.
The Margin of Safety can be calculated using the following formula:
Margin of Safety = Actual Sales − Break-even Sales
Step-by-step Calculation:
Calculate Break-even Sales:
The break-even point in sales (in Rs) is calculated using the formula:
Break-even Sales = Contribution Margin Ratio Fixed Costs
Where the Contribution Margin Ratio (CMR) is:
CMR = Sales Sales − Variable Costs
From the given information:
Fixed Costs = Rs. 1,00,000
Variable Costs = Rs. 1,50,000
Total Sales = Rs. 3,00,000
Calculate CMR:
CMR = 3 , 00 , 000 3 , 00 , 000 − 1 , 50 , 000 = 3 , 00 , 000 1 , 50 , 000 = 0.5
Now, calculate the Break-even Sales:
Break-even Sales = 0.5 1 , 00 , 000 = 2 , 00 , 000 Rs
Calculate Margin of Safety:
Margin of Safety = 3 , 00 , 000 − 2 , 00 , 000 = 1 , 00 , 000 Rs
So, the Margin of Safety is Rs. 1,00,000. This means the business can afford a drop in sales of up to Rs. 1,00,000 before it will start incurring a loss.
The Margin of Safety is calculated as the difference between actual sales and break-even sales. In this case, it is Rs. 1,00,000, indicating how much sales can drop before incurring a loss. This metric is crucial for understanding the financial health of a business.
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