What is Operating Margin?
The Operating Margin (%) represents the residual profits once a company’s cost of goods sold (COGS) and operating expenses are subtracted from the revenue generated in the period.
The operating profit margin establishes a relationship between the operating income of a company (i.e. earnings before interest and taxes, or “EBIT”) and revenue to estimate the profits made prior to paying off non-operating expenses.
How to Calculate Operating Margin (Step-by-Step)
The operating margin is the ratio between a company’s operating profit (i.e. EBIT) and revenue, expressed as a percentage.
The operating profit margin, often referred to as “operating margin,” answers the question, “For each dollar of revenue generated, how much trickles down to operating income (EBIT)?”
The operating income of a company can be calculated by subtracting operating expenses (OpEx) from gross profit, which has already been reduced by the cost of goods sold (COGS) in the period.
With that said, operating income is the remaining earnings once all expenses related to core operations are accounted for (i.e. inclusive of both COGS and OpEx).
For a given period, the accrual accounting-based revenue and operating income of a company can be found on the income statement.
|Revenue to EBIT Bridge||Description|
|Cost of Goods Sold (COGS)||
|Operating Expenses (SG&A)||
|Operating Income (EBIT)||
The COGS line item refers to direct costs such as materials and direct labor, while OpEx consists of expenses related to selling, general & administrative (SG&A) expenses, research & development (R&D) expenses, and more.
The calculation process is as follows:
- Step 1: First, we must find out each company’s revenue, cost of goods sold (COGS), and operating expenses (OpEx) from their income statements.
- Step 2: Next, we’ll calculate the operating income (EBIT) by subtracting OpEx from gross profit.
- Step 3: Lastly, we’ll divide the operating income of each company by the corresponding revenue amount to arrive at the operating profit margin.
Operating Margin Formula
The operating profit margin formula consists of dividing a company’s operating income (i.e. EBIT) by the revenue generated in the same period, as shown below.
To facilitate comparisons across historical periods as well as against industry peers, the operating profit margin is denoted in percentage form, which is achieved by multiplying the value in decimal form by 100.
Operating Margin Calculation Example (%)
For example, if a company has generated $10 million in revenue with $4 million in COGS and $2 million in operating expenses (SG&A), the operating profit is $4 million.
To arrive at the operating profit margin, we’ll divide the $4 million in EBIT by the $10 million in revenue and multiply by 100, which comes out to an operating profit margin of 40%.
- Operating Margin (%) = $4 million ÷ $10 million = .40, or 40%
In this case, the company earns $0.40 in operating income for each $1.00 of revenue generated.
Another way to interpret the $0.40 is that for each $1.00 of revenue generated, the company has $0.40 left to cover non-operating expenses.