The paper "Managerial Accounting - Margin of Safety" is a wonderful example of an assignment on finance and accounting. The margin of safety refers to the number of sale dollars or the number of units by which actual sale can decline below the budgeted or anticipated sales before a loss is registered. It is the rate reduction that can take place before a business breakeven is attained. The concept of margin of safety is useful when an important sales proportion is at risk of elimination or decline, as it might be the case when a contract of sales is coming to an end.
A small margin of safety may trigger action to lower expenses. The opposite condition might occur when the safety margin is considerably high that a business is highly safeguarded from variations of sales. In dollars, the margin of safety computation involves the subtraction of break-even sales from actual or total budgeted sales. It can also be computed in percentage where the obtain margin of safety in dollars is divided by actual or total budgeted sales in dollars. There are two forms of the margin of safety.
They include budget based and unit-based margins of safety. The budget-based margin of safety involves using the budgeted level of sales in place of current sales in the margin of safety computation. The unit-based margin of safety on the other hand involves employing a number of units sold in place of current sales level in the formula (N. a., n.d. ). The term margin of safety was made popular by Benjamin Graham who is regarded as the founder of value investment, together with his followers.
Graham highly employed this concept in the stock market. The margin of safety in the stock market is regarded as an investment principle where an investor only buys securities when the market price is considerably below the intrinsic value. When the market price is considerably below the investors’ intrinsic value estimation, the margin of safety is the difference and this difference permits making of investment with low downside risk. Although the margin of safety does not warranty a successful investment, it gives room for error in the judgment of the analyst.
According to Chew (2015), the determination of the intrinsic value of a company or its true worth is very subjective. This is because every investor contains a varying way of computing the intrinsic value that might or might not be accurate. Moreover, it is highly complex to predict the earnings of a company. In this regard, the margin of safety offers a cushion over calculation errors. The actual concept behind the margin of safety in the stock market can be explained based on Graham’ s principle. Graham founded his principle on simple truths.
He clearly understood that the price of the stock would vary in the future compared to the current value; it could be more or less than the current value in the future. He also understood that the current dollar valuation could be off and this, subjecting investors to avoidable risk. In this regard, Graham established that an investor can substantially reduce his or her risk by purchasing stock at a discount to its true value. Although there is never an assurance that the price of the stock would augment, the discount offers the margin of safety required for an investor to guarantee that losses would be reduced.
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Chew, J. (2015). Chapter 20: “Margin of Safety” as the central concept of investment by Benjamin Graham. Retrieved from < http://www.valuewalk.com/wp-content/uploads/2015/09/Chapter-20_Margin-of-Safety-Concept.pdf>
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N.a. (n.d.). Chapter 3: analysis of cost, volume and pricing to increase profitability. Retrieved from < https://www.google.com/url?sa=t&rct=j&q=&esrc=s&source=web&cd=2&cad=rja&uact=8&ved=0ahUKEwjKtrjZ4bnOAhXlCMAKHYYLAHcQFggiMAE&url=http%3A%2F%2Fhighered.mheducation.com%2Fsites%2Fdl%2Ffree%2F0070900493%2F76580%2FSample_chapter.pdf&usg=AFQjCNGa7u6ZH4VBGxri9ESndeGNqzQpHQ&sig2=HprgNIJL4hxepDkinDwnxA&bvm=bv.129422649,d.d2s>