Margin of Safety in Management Accounting
Management accountants make recommendations that will affect the future of the organization on a regular basis. In order to make a good decision, management accountants need to have an understanding of how much revenue the company needs to break even, how much it is currently earning and how big its margin of safety is. These key components will enable the management accountant to make good recommendations to others within the organization.
Other People Are Reading
-
Cost Types
-
The management accountant will need to classify different expenses into different cost types. Some costs are considered to be fixed costs. These are costs that will not change over the relevant time frame. They may change in the long term, but will remain constant for at least a year. Variable costs will change as production volumes change. As the total production increases, so will the variable costs.
Contribution Margin
-
The contribution margin determines how much additional money will be contributed to the bottom line as each additional unit is sold. This number is calculated by taking the selling price per unit less the variable cost per unit. The contribution margin contributes to paying fixed expenses and increasing profits. It may be stated in total, per unit or as a ratio.
-
Break Even Analysis
-
Break even analysis calculates the number of units required to be sold or the total sales dollars necessary for the company to break even and earn a profit of zero. The break even point can be calculated by taking the total fixed expenses divided by the unit contribution margin. This will calculate the number of units necessary to sell in order to break even. The number of units can be multiplied by the selling price per unit to determine break even sales dollars. If the sales are any less than those required to break even, the company will lose money.
Margin of Safety
-
Most companies that continue to remain in business earn a profit and sell more than is required for their break even point. The actual sales minus the break even sales are the margin of safety.
Levels
-
A company may have a low level of margin of safety. In this case, if it loses just a few sales, it may go below the break even point and lose money. This company should try to increase its sales or reduce its expenses in order to increase its margin of safety. A company with a high level of margin of safety has less chance of going below break even and losing money.
-
References
- Photo Credit working at lacquer factory image by Alexey Stiop from Fotolia.com
