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Define the term margin of safety - Leaving Cert Business - Question C - 2021
Question C
Define the term margin of safety. Discuss one limitation of a breakeven analysis when making business decisions.
Worked Solution & Example Answer:Define the term margin of safety - Leaving Cert Business - Question C - 2021
Step 1
Define the term margin of safety.
Answer
The margin of safety is a financial metric that measures the amount by which sales can drop before a business reaches its breakeven point, where it covers all its fixed and variable costs. It is calculated as the difference between actual sales and breakeven sales, often expressed as a percentage of actual sales. This concept helps businesses assess risk and make informed decisions regarding their operations and financial strategies.
Step 2
Discuss one limitation of a breakeven analysis when making business decisions.
Answer
One limitation of breakeven analysis is that it assumes all costs can be classified as either fixed or variable, which may not reflect the reality of many business environments. In practice, some costs can be semi-variable or change with different levels of production, making it difficult to accurately determine the breakeven point. Additionally, this analysis typically does not account for changes in market demand, competition, or other external factors that can impact sales and costs, potentially leading to misguided business decisions.