The operating margin shows how much profit a company earns from each dollar of sales after covering variable production costs like wages and raw materials, but before accounting for interest or taxes. You can find it by dividing the company’s operating income by its net sales. A higher ratio is usually a good sign, indicating that the company runs efficiently and effectively converts sales into profits.
Learn more about Operating Margin
A company’s operating margin, often called return on sales (ROS), is a solid measure of how well it’s being run and how effectively it’s turning sales into profits. It indicates the share of revenue that can be used to handle non-operating expenses, like interest payments, which is why it’s a key focus for investors and lenders.
When operating margins fluctuate a lot, it signals higher business risk. Similarly, checking out a company’s historical operating margins can help assess if its performance is improving over time. Operating margins can get better through smarter management, more efficient resource use, better pricing strategies, and stronger marketing efforts.
Basically, the operating margin reflects how much profit a company earns from its main business activities compared to its total revenue. This helps investors determine if a company is making money mainly from its core operations or from other sources, like investments.
Calculating the Operating Margin
The formula for operating margin is:
Operating Margin= (Operating Earnings/Revenue)To figure out the operating margin, you start with a company’s earnings before interest and taxes, known as EBIT. You can find EBIT, or operating earnings, by taking the total revenue and subtracting the cost of goods sold (COGS) along with the usual selling, general, and administrative expenses, while leaving out interest and taxes.
Why is It Important?
The operating margin is a key indicator of how profitable a company is from its core activities. It compares the operating profits to the total revenues of the business or a specific segment.
When you look at it as a percentage, the operating margin reveals how much profit a company makes from each dollar of sales after covering the direct costs associated with generating that revenue. Higher margins indicate that a greater portion of each sales dollar is retained as profit.