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Margin of Safety
The margin of safety is the amount by which the volume
can be reduced from the actual or expected output level before reaching
the break-even point. In the above example, if the expected level of
output is 7,000 units the margin of safety is 2,000 units. It can also
be expressed as a percentage (28.6% of expected output) or in terms
of sales value (£68,000 of sales revenue at £34 per unit). The margin
of safety provides a good indication of the vulnerability of a company
to unexpected downturns in demand.
The Profit/Volume Ratio is the rate at which profit
increases with sales, rather than a simple ratio of profit and sales.
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This is because fixed costs which are
unaffected by volume must be divided by volume to give a fixed cost per
unit. Fixed cost per unit is a function of volume so for any given level
of volume, a different profit per unit (i.e. selling price - variable
costs per unit - fixed costs per unit) can be calculated. Contribution
per unit is constant, so Contribution /Sales (£14/£34 or 41% above) is
a constant ratio. .(Note. this is the same as (Profit + Fixed Costs)/Sales).
Also, in the graph above volume is expressed in units, rather than sales
value.)
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