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Operating Margin Ratio

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Examples

Example 1:

Compare the operating margin for Tischla Hair Salon and Spa to its industry, when:

  • Industry-average operating margin = 10%
  • Monthly sales = $928,300
  • Monthly operating income = $113,200

Operating margin = Operating Income ÷ revenue = $113,200 / $928,300 = 12%

The salon is more profitable than its industry average.

Example 2:

What’s the net profit of Games for Kids of All Ages, when:

  • Cost of goods sold = $34,390
  • Gross profit = $42,030
  • Other operating costs = $37,200
  • Revenue = cost of goods sold + gross profit = $34,390 + $42,030 = $76,420
  • Operating Income = gross profit - other operating costs = $42,030 − $37,200 = $4,830
  • Operating margin = $4,830 + $76,420 = 0.063 or 6.3%

Operating Margin Ratio Definition

Operating margin (or net profit) measures operating income as a percentage of revenue. Calculated as the ratio of operating income of a business to its revenue, the ratio indicates a company’s profitability. Operating margin can be considered total revenue from product sales minus all costs before adjustment for taxes, dividends to shareholders, and interest on debt.

A good operating margin enables a company to pay fixed costs, such as debt interest. Generally, more efficient businesses can control their overall costs. Higher operating margins indicate this ability.

NOTES:

  • Operating income is another term for earnings before interest and tax (EBIT).
  • Look for operating income and revenue values in the company income statement.

Analysis

Analysts view higher operating margins as a good sign of business health. That’s because a greater proportion of total revenue becomes operating income. If operating margins increase over time, the company is becoming more profitable. And, it’s more likely to pay its debts on time. Comparing the gross margin ratio of a business to its average gross profit margin of the industry is one way of viewing its general creditworthiness.