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What is the difference between the margin of safety and break-even point? - YouTube
Channel: Chris Menard
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Hello, I'm Chris Menard.
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I have a great video today.
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I'm going to discuss what is the difference
between the breakeven versus the margin of
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safety.
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This question came from one of my YouTube
subscribers.
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I've already created two videos on the breakeven
point.
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Both will be down below.
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One covers, just one product, figuring out
the breakeven, but then I did a breakeven
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analysis chart on that.
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The second video also came from that video.
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Someone said, we only did one product.
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In real life, we have multiple products, so
I did breakeven analysis with multiple products.
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That video has also got a link down below.
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So the break even point, I've got to figure
that out prior to doing the margin of safety,
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you just have to.
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The break even point is where your net income
is zero.
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You're not making money, you're not losing
money, you're breaking even.
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Break even is part of cost volume profit analysis.
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Safety margin is the difference between what
you have budgeted versus your break even.
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So I'm going to cover this today for both
units, dollars and even a percentage for the
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margin of safety.
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So the numbers in here that I'm using for
this example, I'm making up.
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So here we go.
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But whenever I do a formula, I'll put the
formula over in column C. So whatever this
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is we have, we're going to do it for $40 a
unit.
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Variable costs are direct material, direct
labor or examples.
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So the more volume you do, the higher your
total variable cost will be, cause they're
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directly tied into the units.
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So really $40 is what people buy it for.
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It costs us $32 in variable materials and
variable costs.
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So therefore our contribution margin, basically,
what are we really making per each unit after
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the variable costs?
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Eight bucks.
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Now we've got fixed costs.
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At our plant, that would be our rent, we've
got to pay for security, we got to pay for
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insurance for the building, a lot of different
fixed costs.
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They don't change per period.
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I don't care if the period is a month, a quarter
or a year, whatever you want this to be, I'm
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going to make that $7,000.
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Whether we make any units or not, we've got
to pay that $7,000.
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So our budgeted units, again, I'm making this
up, we believe we're going to do a thousand
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dollars a period.
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So here you go, $40 for every unit, that's
what people pay for it, times 1000.
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Forty thousand.
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Let me go ahead and do some formula texts
over here for you.
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I know that's a formula B1 minus B2, and there's
another formula.
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So here comes our break even point.
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Net income is going to be zero, no loss, no
profit.
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Break even in units is simply, we've got to
pay that 7,000 fixed cost, every period.
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What do we actually make per unit to cover
that fixed cost?
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Not $40.
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$8.
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So our break even point in unit is 875 units.
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If you did 875 times 40, which is what I'm
about to do.
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875 times 40, there is your breakeven point
in dollars.
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So now we've got our breakeven point and we
know what our budget is.
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So now you can figure out the margin of safety.
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Without rows 7 and 8, I can't do it.
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So I'm going to do the margin of safety in
dollars, in a percentage and in units.
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So this one's really simple.
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We budgeted for 40,000, our break even point
is 35,000.
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That is the margin of safety in dollars.
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Whatever you've budgeted to do minus your
breakeven in dollars, $5,000.
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So hopefully we make the 40,000, but if we
don't, if we did 38,000, we're still within
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our margin of safety, cause we're not losing
any money.
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If we did $36,000, we're still okay.
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If we did $34,000, now we have a net loss
because we're below the break even in dollars.
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That $5,000 is our safety margin.
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What is that, as a percentage?
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It's simply the $5,000 divided by your total
budgeted.
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I've already formatted that as a percentage
so that is your 12.5% right there.
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And then finally, the last item, what is our
margin of safety in units?
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So we already said it's $5,000.
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Really simple, how many units did we budget
for?
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A thousand minus, what is our break even in
units?
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Again, you see why you have to do the break
even first.
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So 1000 units minus 875 units is 125 units.
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That is also a formula, so let me pull that
down.
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So there are your three different margins
of safety that I did.
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I had to do the break even point first.
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Break even, just remember not making any money,
not losing any money.
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There you go.
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I hope that answers that question.
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Couple easy observations, if you can reduce
your fixed costs, that always is going to
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help.
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Think about yourself personally, with your
finance.
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You got your house note, you've got your car
note, you've got your car insurance, you've
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got your homeowner's or renter's insurance.
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Those are all fixed costs.
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The lower, the better, I believe you agree
with me on that one here.
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Also, what else?
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So lower the fixed costs.
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Also the variable cost per unit, the lower
off, you're better.
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I'm making this example up.
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Let's say we went back and looked at this
and said, Hey, it's not $32 a unit, it's only
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28.
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By changing this to 28, all these numbers
and even percentages get much better.
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So there it is at 28 right there.
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Margin of safety in units is now 417, because
the break even in units went drastically down.
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I'm going to go back to 32 to show the difference
again.
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That is it.
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I don't want to take any more of your valuable
time.
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I appreciate it.
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Feel free to catch my other two videos on
breakeven, especially if you need the chart.
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That is the very first break even video.
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And the second break even again, is if you've
got multiple products, I did, what's called
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a product mix.
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If you have any comments or questions about
this video, please let me know.
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Have a wonderful day and as always feel free
to subscribe.
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Thank you.
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