ACCA Performance Management (F5) Certification Practice Exam

What does 'margin of safety' measure?

1. The difference between budgeted level and fixed costs

2. The difference between budgeted level and break-even level of activity

3. The total profit earned beyond the breakeven point

4. The maximum possible loss before reaching breakeven

The correct answer is: The difference between budgeted level and break-even level of activity

The concept of 'margin of safety' specifically measures the difference between the budgeted level of activity (or sales) and the break-even level of activity. It reflects how much sales can drop before the business reaches its breakeven point, where total revenues equal total costs, and no profit or loss occurs. This measurement is crucial for business decision-making as it indicates the risk level associated with sales fluctuations. A higher margin of safety suggests a cushion that allows a company to sustain operations even if sales decrease, whereas a lower margin of safety indicates greater risk and less financial flexibility. The margin of safety essentially provides insight into the company's operational buffer, helping managers to understand how much of their expected sales are at risk before they encounter financial difficulties. Understanding this helps in strategic planning, risk assessment, and financial forecasting.