What is the Operating Profit Margin?

Operating Margin Formula

Investors avidly use it because the investors can get to know how much a firm earns in terms of operating profit. Here’s the formula of operating margin –

Key Takeaways

  • The operating profit margin is a measure of the firm’s credibility that helps measure the profit derived from the operations the firm has. The company makes certain deductions before it can reach the ratio, such as taxes and interest rates. The operating profit margin is calculated by dividing the operating profit by net sales and multiplying it by 100 to retain a percentage. Investors look for the operating profit margin to gauge the actual operational efficiency of the company and understand its profitability.

Operating Margin Formula = Operating Profit/Net Sales * 100

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In the above operating margin formula, we have two important components.

The first component is the operating profit.

  • We get to the operating profit by deducting the cost of goods soldCost Of Goods SoldThe Cost of Goods Sold (COGS) is the cumulative total of direct costs incurred for the goods or services sold, including direct expenses like raw material, direct labour cost and other direct costs. However, it excludes all the indirect expenses incurred by the company.
  • read more and other expenses from the net sales. And if you look at the income statement of a company, you would be able to discover the operating earningsOperating EarningsOperating Earnings is the amount of profit a company earns after deducting direct and indirect costs from sales revenue. It is also referred to as EBIT, which stands for profits before interest and taxes.read more quite well. The specialty of operating income is that it doesn’t include income and expenses except those related to the operating profit.The second component in the above operating margin formula is net sales. We start the income statement with the gross sales. Gross sales are the total revenue earned by the company. But to find out the net sales, we need to deduct any sales return or sales discount from the gross sales.

And in the operating margin ratio above, we compare the operating profit and the net sales to find out the proportion.

Example of Operating Margin

Let’s take a simple example to illustrate the operating margin formula.

  • Gross Sales – $564,000Sales Return – $54,000Cost of Goods Sold – $2,40,000Labour Expenses – $43,000General & Administration Expenses – $57,000

Find out the operating profit margin of YOU Matter Inc.

In this example, first, we need to find the net sales of YOU Matter Inc.

  • Gross sales are $564,000, and the sales return is $54,000.Then the net sales would be = (Gross Sales – Sales Return) = ($564,000 – $54,000) = $510,000.

We need to deduct the cost of goods sold from net sales to find out the gross profit.

  • Then the gross profit would be = (Net Sales – Cost of Goods Sold) = ($510,000 – $240,000) = $270,000.

Now we will deduct the operating expensesThe Operating ExpensesOperating expense (OPEX) is the cost incurred in the normal course of business and does not include expenses directly related to product manufacturing or service delivery. Therefore, they are readily available in the income statement and help to determine the net profit.read more from gross profit to determine the operating profit.

  • The operating profit would be = (Gross profit – Labour expenses – General and Administration expenses) = ($270,000 – $43,000 – $57,000) = $170,000

Using the operating margin formula, we get –

  • Operating Profit Margin formula = Operating Profit / Net Sales * 100Or, Operating Margin = $170,000 / $510,000 * 100 = 1/3 * 100 = 33.33%.

Colgate Example

Below is the snapshot of Colgate’s Income Statement from 2007 to 2015.

  • Colgate’s Operating Profit = EBIT / Net Sales.Historically, Colgate’s Operating Profit has remained in the range of 20%-23%

However, in 2015, Colgate’s EBIT MarginEBIT MarginEBIT Margin is a profitability ratio that is used to determine how successfully and efficiently a business can manage its operations. The formula is as follows: Gross Profit/Total Sales*100.read more decreased significantly to 17.4%. This was primarily due to a change in accounting terms for the CP Venezuela entity (as seen below)

Uses

Many firms emphasize net profit. The net profit results from the whole income and expenses rendered by a company. But if the net profit margin is higher, it doesn’t ensure the efficiency of a company. Rather, it may hide the actual profit generated by the operating efforts of the company.

That’s why the investors should look at operating profit. Since operating profit helps determine how much profit the companies have made from their operations, it ensures efficiency and profitability. And that’s the reason – it is one of the most significant profitability ratiosProfitability RatiosProfitability ratios help in evaluating the ability of a company to generate income against the expenses. These ratios represent the financial viability of the company in various terms.read more of all.

While finding out the profit margin, the investors should look at gross profitGross ProfitGross Profit shows the earnings of the business entity from its core business activity i.e. the profit of the company that is arrived after deducting all the direct expenses like raw material cost, labor cost, etc. from the direct income generated from the sale of its goods and services.read more margin and net profit margin; along with that, they should look for the operating margin, which will surely bridge the gap in understanding how a company is doing operationally.

Operating Margin Calculator

You can use the following Operating Margin Calculator.

Calculate Operating Margin in Excel

Let us now do the same example of the operating margin formula in Excel. This is very simple.

First, you need to find the Net Sales and Gross Profit, and then you will need to deduct the operating expenses from gross profit to find out the operating profitFind Out The Operating ProfitOperating profit formula measures the efficiency of the company to run its business by calculating the operating profit of the company. Operating profit is the profit generated from the core business after deducting all the related operating expenses, depreciation, and amortization from its revenue but before deducting interest and taxes.read more. Then by using the operating Margin formula, we will calculate Operating Profit Margin.

You can easily calculate the operating margin ratio in the template provided.

First, we need to find the net sales of YOU Matter Inc.

To find the gross profit, we need to deduct the cost of goods sold from net sales.

Operating Profit Margin Formula Video

Recommended Articles –

This article has been a guide to operating profit margin and its meaning. Here we discuss the formula to calculate operating profit margin and practical examples, uses, and interpretations. You can learn more about from the following articles –

Any high operational margin is considered suitable for the business because it simply means better operational functionality for the business and attracts investors and fund managers.

No, the operating profit margin and the gross profit margin are different because the gross profit margin only considers direct costs. In contrast, the operating profit margin includes all expenses, such as overheads.

EBITDA and Operating Margin are different names for the same concepts. Both indicate the profit of the company. However, EBITDA includes taxes, depreciation, amortization, and interest, whereas operating margin excludes the following.

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