Margin of Safety CVP analysis assumes linear cost and revenue functions, no finished goods ending inventories, a constant sales mix, and that prices and costs are known with certainty. However, at least one assumption does not hold in practice. In particular, firms often do not know the prices, unit variable costs, and fixed costs that will occur in the future. This uncertainty regarding costs, prices, and sales mix affect the breakeven point. Sensitivity analysis allows managers to vary costs, prices, and sales mix to show various possible break-even points. This type of analysis also allows managers to model the impact of nonlinear cost and revenue functions, as they can choose the budgeted units and use the unit cost or price that is associated with that level. Spreadsheets make this kind of analysis much easier. Determination of the margin of safety allows managers to see how much the company's actual sales or units are above or below the break-even point. Margin of safety in dollars - Actual sales - Break-even sales Margin of safety in units = Actual units sold - Break-even units Example: Lesher Company makes one product with the following price and cost structure: Price $12.00 Unit variable cost $8.40 Total fixed cost $50,400 Next year, Lesher Company expects to sell 18,000 units. What is the expected margin of safety in units and sales dollars? Break-even units = $50,400/($12.00 - $8.40) 14,000 units 4 Next year, Lesher Company expects to sell 18,000 units. What is the expected margin of safety in units and sales dollars? Break-even units = $50,400/($12.00 - $8.40) = 14,000 units Break-even sales = 14,000 x $12 - $168,000 Margin of safety in units = 18,000 - 14,000 = 4,000 Margin of safety in sales dollars = ($12 x 18,000) - $168,000 = $48,000 Suppose Lesher Company's price next year dropped to $11, the margin of safety would Suppose instead that Lesher Company expected unit sales next year of 18,600, the margin of safety would If the margin of safety equals zero, then the company is selling Select "Yes or No" from the following actions which can increase the margin of safety for a company. Increasing fixed costs. Increasing break-even units. Increasing actual price. Decreasing actual price. Decreasing unit variable cost