How to Find Operating Margin: Formula & Calculation
Gain a clear understanding of how to measure a company's core operational profitability and efficiency from its main business.
Operating margin serves as a key financial metric, offering insight into a company’s operational profitability. It helps assess how efficiently a business generates profit from its core activities. This measure provides a view of a company’s ability to control costs and convert sales into operating earnings before considering the impact of interest and taxes.
What Operating Margin Measures
Operating margin reflects how much profit a company retains from each dollar of sales after covering both variable and fixed costs associated with its primary business operations. It highlights a company’s ability to manage its core business activities profitably, independent of its financing structure or tax obligations. By focusing on profits derived solely from operations, the operating margin helps stakeholders understand the underlying health of the business.
Identifying the Necessary Financial Figures
To calculate the operating margin, two primary financial figures are required: Operating Revenue and Operating Expenses. Operating Revenue, also known as sales revenue or net sales, represents the income generated directly from a company’s primary business activities, such as selling goods or providing services. This figure is typically found at the top of a company’s income statement, often labeled as “Revenue” or “Net Sales.”
Operating Expenses encompass the costs incurred during normal business operations, excluding the direct cost of goods sold, interest, and taxes. Common examples include selling, general, and administrative (SG&A) expenses, which cover items like salaries, rent, utilities, marketing, and office supplies. Research and development (R&D) expenses, depreciation, and amortization are also considered operating expenses. These figures are also located on the income statement, usually presented below the gross profit section.
Performing the Calculation
The calculation of operating margin begins with determining operating income, which is derived from the figures identified on the income statement. Operating income is found by subtracting total operating expenses from operating revenue. This result reflects the profit generated from a company’s core operations before accounting for non-operating items like interest and taxes.
Once operating income is established, the operating margin can be calculated using a straightforward formula. The operating income is divided by the operating revenue, and this result is then multiplied by 100 to express it as a percentage. For example, if a company has an operating income of $300,000 and operating revenue of $1,000,000, its operating margin would be 30%. This percentage indicates how many cents of operating profit a company earns for every dollar of sales.
Understanding the Calculated Percentage
The calculated operating margin percentage offers insight into a company’s operational efficiency. A higher operating margin generally indicates that a company is more effective at managing its costs and converting sales into profit from its core business activities. This suggests strong internal controls and efficient resource allocation. Conversely, a lower operating margin may signal inefficiencies, higher operational costs, or intense competition within an industry.
Analyzing this percentage over time can reveal trends in a company’s performance, showing whether its operational profitability is improving or declining. Comparing a company’s operating margin to industry averages or the performance of its competitors provides valuable context, as acceptable margins can vary significantly across different sectors.