The problem with the 25% margin of safety is that it is not actually a realistic number. It is based on the idea that your sales can’t fall below the 25% margin of safety. In reality, you would need to sell more than $4,000,000 in order to break even.
If a business had sales of $4,000,000 and a margin of safety of 25%, the break-even point would be $4,000,000. I say this because the 25 margin of safety really is very, very low. If sales were $10,000,000 and the margin of safety was 50%, the break-even point would be $10,000,000.
In reality, if your sales were 100% of your margin of safety, you would actually need to sell 100,000 in order to break even. If your sales were 100% of 10,000,000, you would actually need to sell 10,000 in order to break even. I am now going to use the margin of safety of 25 as an example of how a business that has a 25 margin of safety might handle a business that has a sales figure of 100,000.
Your margin of safety is the amount of money that can be made if you have a 100% profit rate. You can think of it as the amount of money that you can make if you do not make any expenses, and you make no sales.
In the example above, you can make a profit of 100 percent of that total, but you have to pay 100 percent of your expenses. The margin of safety is the amount of money that you make if you have to make no sales and make no expenses. At any point in time, you can sell all of your 10,000 items for 100 percent of your total sales price. You can break even.
So far, we’ve only had an example where a company has had a 100 profit rate and a 25 margin of safety. But the examples above are real.
Its not as much fun trying to make those calculations but the math does seem to be very clear.
If your company does in fact have a “margin of safety” of 25% (or even more) then you can expect to see your profits explode. We all know that the average profit on one of our companies’ products (e.g., our books) is over $2,000 per sale, and we also know that the average profit margin for eCommerce businesses is between 5 and 10 percent.
As you can see, we have a wide array of products and they all perform well and sell well. However, if your company has higher sales or a higher margin then the average profit rate (or average margin of safety) will change. It’s not as clear cut as the example above, where if your company is selling $1,000,000 a year you could expect your profits to grow by 25% if your margins were 25%. But the average profit rate may be higher.
The most basic example is a company that sells products at the $5,000-10,000 range. If your company sells $4,000,000 a year in products at this price, you can expect to make a profit of 7,800 percent. If you are selling $12,000,000 in products then your profit will be 13,600 percent.