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How to Compute the Margin of Safety

Original post by Mark Kennan of Demand Media

Companies with a lower margin of safety may lose money in a difficult economic climate.

The "margin of safety" refers to how much money a company makes in excess of its breakeven point. The breakeven point is the minimum amount of money necessary to prevent the company from losing money. Many investors prefer companies that have little risk of being unprofitable from year to year. Companies with a high margin of safety can weather a poor market without losing money. You can calculate the margin of safety based on a company's breakeven point and its total profits for the year.

Contents

Step 1

Subtract the breakeven point from the company's current sales results. For example, if a business has \$6.7 million in gross sales per year but only needs \$5.5 million to break even, subtract \$5.5 million from \$6.7 million to get a margin of \$1.2 million.

Step 2

Divide the margin by the sales to determine the margin of safety as a decimal. In this example, divide \$1.2 million by \$6.7 million to get 0.1791.

Step 3

Multiply the margin of safety as a decimal (calculated in the preceding step) by 100 to convert the value to a percentage. Concluding this example, multiply 0.1791 by 100 to get 17.91 percent. This means that the company could withstand a 17.91 percent decrease in its sales before it would not have a profitable year.

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