Difference between Breakeven Point vs. Margin of Safety

Break-even point (BEP) is the level of sales where a total of fixed and variable costs equals total revenues. In other words, the breakeven point is a level where the company neither makes a profit nor a loss. A margin of safety (MoS) is a difference between actual/budgeted sales and the level of breakeven sales. Let us see in detail the breakeven point vs. margin of safety.

Although the breakeven point (level) and margin of safety fall under the broad domain of cost-volume-profit analysis (CVP Analysis), they differ in various aspects. The main points of difference between the breakeven point and margin of safety are as listed below:

The breakeven point means an amount of sales that cover entire fixed and variable costs. Sales lower than the BEP will result in losses, while the sales above the BEP will generate profit after considering all the costs.

As the name suggests, the Margin of Safety is the margin between the actual/budgeted sales and the breakeven point. It denotes the level of safety that the company enjoys before incurring losses (i.e., falling below the breakeven level).

Interpretation of Breakeven Point and Margin of Safety

  • Breakeven point is a measure of sustenance, while the margin of safety is a measure of risk.
  • The lower the breakeven quantity, the better it is for the companies, while the higher the margin of safety, the better it is for the company.

Breakeven Point vs. Margin of Safety: Example

Let us calculate and compare the breakeven point with the margin of safety using the following data.

Sales price per unit = $ 50

Variable cost per unit = $ 30

Total fixed cost = $ 7,000

Total sales quantity = 500 units

Breakeven Point Formula – Equation

Breakeven Sales = Total Variable Cost + Total Fixed Cost

Assuming a breakeven quantity of ‘q.’

The breakeven value of sales will be 50 X q

The total Variable cost will be 30 X q

The total fixed cost will be the same as it does not change with a change in sales quantity.

The formula shall now look as follows:

50q = 30q + 7000   —> 50q – 30q = 7000  —> 20q = 7000  —> q = (7000/20) —> q = 350

Therefore upon solving, the breakeven quantity ‘q’ = 350 units.

Hence the breakeven sales will be 50 X q = 50 X 350 = $ 17,500

The breakeven point can be calculated using a rephrased approach known as the contribution method, which is as follows:

Breakeven Point Formula – Contribution Method 

Contribution Per Unit = Selling Price Per Unit – Variable Cost Per Unit

= $ 50 – $ 30 = $ 20

Breakeven Quantity = Total Fixed Cost / Contribution Per Unit

= $ 7000 / $ 20

= 350 units.

Breakeven Sales = 350 (Breakeven Quantity) X $ 50 (Selling Price) = $ 17,500

Margin of Safety Formula  

Margin of Safety = Total budgeted or actual sales – Breakeven sales

Assuming Actual Sales = 500 units

= (500 X 50) – (350 X 50)

i.e.,

= 25,000 – 17,500

= $ 7,500

Margin of Safety as a Percentage of Sales = ($ 7,500/ $ 25,000) %

= 30%

Advantages and Uses 

Advantages of Breakeven Point Analysis

  • BEP analysis helps understand the relationship between fixed cost, variable cost, and the level of profitability.
  • It provides the business with a minimum sales level which the company needs to achieve to avoid losses.
  • It also indicates how any change in selling price would impact the profitability and BEP.
  • BEP can be used as one of the indicators that help decide whether to manufacture a new product yourself or outsource.

Advantages of Margin of Safety

  • It helps to know how much cushion the company has if sales decline before the company starts making losses.
  • Higher MoS provides freedom to the company’s management to alter the selling price of their product to gain market share from its competitors.
  • A higher margin of safety allows the company to spend more on an advertisement or other activities that can help in improving sales in the long run.
Break even point and margin of safety

Disadvantages of Breakeven Point and Margin of Safety

  • Break-even point analysis is more appropriate in the case of analysis of a single product at a time; it fails to do so appropriately in the case of a multi-product scenario. Many times it isn’t easy to classify a cost as fixed or variable.
  • The margin of safety, which turns out to be very high, may cause management to lead to inappropriate use of excess funds. At times, a higher margin of safety may lead to higher risk-taking behavior of the management, which may not always be required.

Conclusion

The CPV Analysis for any company would remain incomplete unless one calculates breakeven point analysis and margin of safety along with other costs and ratios. Though there are limitations to using breakeven point analysis and calculating margin of safety, these continue to remain a vital part of any company’s cost profit-volume analysis.

Quiz on Breakeven Point vs Margin of Safety

This quiz will help you assess yourself on how much you have learned about Breakeven Point and Margin of Safety from the above article.



Sanjay Borad

Sanjay Bulaki Borad

Sanjay Borad is the founder & CEO of eFinanceManagement. He is passionate about keeping and making things simple and easy. Running this blog since 2009 and trying to explain "Financial Management Concepts in Layman's Terms".

3 thoughts on “Difference between Breakeven Point vs. Margin of Safety”

    • Margin of Safety = Profit/PVR
      = 1000/ 20 %
      = Rs 5000
      PVR = Fixed cost/ BEP * 100
      =Rs 12000/ Rs 60000 * 100
      = 20 %

      Reply
  1. It is very useful n easy to understand. But could u please elaborate on certain things like mention the meaning, uses, features, advantages n disadvantages of the all d topics covered under Marginal costing of Third year Bcom. Would be very helpful to all if done specifically.

    Reply

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