Operating Margin

What is Operating Margin?

Operating margin or operating profit margin is a profitability ratio measuring revenue after covering for operating and non-operating expenses of a business entity.  Also called as return on sales, the operating income is the basis of how much of the portion of the generated sales is left when all operating expenses are paid off.

 

 

What is the formula for Operating margin?

 

Operating Margin = Operating Income / Net Income  X 100%

 

To illustrate:

DT Clinton Manufacturing company reported on its 2015 annual income statement a total of $125M in sales revenue. Operating income before tax netted to $45M after deducting all operating expenses for the year. As a result, profit margin of 36% was generated after defraying all the operational expenses of $80M. Hence, for every dollar in sales achieved, $0.36 cents is retained as profit.

 

 

What is Operating Income?

Operating income is the profit of a business after all operating expenses are deducted from sales receipts or revenue.  It represents how much a company is making from its core operations not including other income sources not directly related to its main business activities. This gives an idea for investors and creditors if a company’s core business is profitable or not.

 

 

What is Sales Revenue?

Sales revenue or net sales is the monetary amount obtained from selling goods and services to business customers excluding the merchandise returned and the allowances/discounts offered to them.  This can be realized either as cash sales or credit sales.

 

 

Why is Profit Margin important in business?

A business that is capable of generating operating profit rather than operating loss is a positive sign for potential investors and existing creditors. This only means that the company’s operating margin creates value for shareholders and continuous loan approval for lenders. The higher the margin that a company has, the less financial risk it has as compared to a lower ratio.  Further increase in profit margin over time shows that profitability is improving. This may either be attributed to an efficient control of operating costs or other factors that influence revenue build-up such as pricing, marketing, and increase in customer demand.

 

 

Read more about profit and loss metrics: