SENSITIVITY ANALYSIS OF CVP RESULTS
-examining the sensitivity of profits to changes in sales, either of the measures may
be used:
a. Margin of Safety – potential effect of the risk that sales will fall short of planned
levels
b. Operating Leverage – potential effect of the risk that sales will fall short of
planned levels as influenced by the relative proportion of fixed to variable manufacturing
costs
Margin of Safety
–amount of sales that the company can afford to lose before a loss is incurred,
computed as:
Margin of Safety = Actual or Planned Sales - BEP
(excess of sales over the break-even point)
The margin of safety (MS) can be viewed as a crude measure of risk. There are always
events, unknown when plans are made, that can lower sales below the original
expected level. If a firm’s margin of safety is large given the expected sales for the
coming year, the risk of suffering losses should sales take a downward turn is less than
if the margin of safety is small. Managers who face a low margin of safety may wish to
consider actions to increase sales or decrease costs.
The margin of safety can also be used as a ratio, a percentage of sales as follows:
Margin of Safety ratio = Margin of Safety
Actual or Planned Sales
The margin of safety ratio (MSR) is useful for comparing the risk of two alternative
products, or for assessing the riskiness in any given product. The product with a relatively
low margin of safety ratio is the riskier of the two products and therefore usually
requires more of management’s attention.