Marginal costing
This query is : Resolved
Arpit Shah
(Expert)
08 February 2016
Margin of Safety vs. Profit
Margin of safety and profit are elements of accounting that use revenue as the basis of computation, but each is entirely different. Margin of safety helps you anticipate harmful sales levels, while profit measures your earnings. Understanding their differences can help you maximize your business's efficiency.
Objectives
In an income statement, profit is the bottom line. Its objective is to show you how much income or loss was earned during a given accounting period. Margin of safety is used to determine what percentage that sales can decrease before a business generates a net loss. It reveals what percentage of sales is above the break-even point.
Users
Margin of safety is normally used by a company's management to determine profitability levels that result from sales fluctuations. Parties that are not directly involved in a company's financial management seldom view a company's margin of safety. An income statement showing the amount of profit earned by a company is read by parties with vested interest, such as owners, investors, creditors, and tax collectors.
Time Frame
The time frame covered in profit and margin of safety is different. Profit or loss is computed using revenue and expense accounts from past accounting periods. Margin of safety is computed to show sales limits in anticipation of future fluctuations in sales levels. The purpose of figuring profit is to measure past transactions, while the reason for finding margin of safety is to guide future decisions.
Computation
Profit is computed by deducting cost of goods sold and operating expenses from sales. Margin of safety is the result of deducting break-even point sales from total sales, dividing the resulting difference by total sales, and multiplying the product by 100. For example, a company with total sales of $100,000, cost of goods sold of $60,000, and total operating expenses of $30,000 would yield a net profit of $10,000 ($100,000 minus $60,000 minus $30,000). If the same company had a break-even point sales of $70,000, its margin of safety would be 30 percent ($100,000 minus $70,000 divided by $100,000 multiplied by 100).
Margin of safety and profit are elements of accounting that use revenue as the basis of computation, but each is entirely different. Margin of safety helps you anticipate harmful sales levels, while profit measures your earnings. Understanding their differences can help you maximize your business's efficiency.
Objectives
In an income statement, profit is the bottom line. Its objective is to show you how much income or loss was earned during a given accounting period. Margin of safety is used to determine what percentage that sales can decrease before a business generates a net loss. It reveals what percentage of sales is above the break-even point.
Users
Margin of safety is normally used by a company's management to determine profitability levels that result from sales fluctuations. Parties that are not directly involved in a company's financial management seldom view a company's margin of safety. An income statement showing the amount of profit earned by a company is read by parties with vested interest, such as owners, investors, creditors, and tax collectors.
Time Frame
The time frame covered in profit and margin of safety is different. Profit or loss is computed using revenue and expense accounts from past accounting periods. Margin of safety is computed to show sales limits in anticipation of future fluctuations in sales levels. The purpose of figuring profit is to measure past transactions, while the reason for finding margin of safety is to guide future decisions.
Computation
Profit is computed by deducting cost of goods sold and operating expenses from sales. Margin of safety is the result of deducting break-even point sales from total sales, dividing the resulting difference by total sales, and multiplying the product by 100. For example, a company with total sales of $100,000, cost of goods sold of $60,000, and total operating expenses of $30,000 would yield a net profit of $10,000 ($100,000 minus $60,000 minus $30,000). If the same company had a break-even point sales of $70,000, its margin of safety would be 30 percent ($100,000 minus $70,000 divided by $100,000 multiplied by 100).
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