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How Do Companies Calculate the Operating Margin?

Updated: Jan 5, 2023


What Does an Operating Margin Tell You?


Operating margin is a measure of a company's profitability. It is calculated by dividing the company's operating income by its revenue. Operating income is the company's income from its normal business operations, before taking into account taxes and interest expenses. Operating margin is expressed as a percentage and is a good way to compare the profitability of different companies in the same industry, as it shows the percentage of each sales dollar that the company retains as operating income. A higher operating margin indicates that a company is more profitable, as it is able to generate more income from its operations relative to its revenue.


How Can You Increase Your Company's Operating Margin?


There are several ways that a company can increase its operating margin:

  1. Increase prices: One way to increase operating margin is to increase the prices of the company's products or services. This can help to increase revenue and operating income.

  2. Reduce costs: Another way to increase operating margin is to reduce the company's costs. This can be done by negotiating better terms with suppliers, improving manufacturing processes to reduce waste, or cutting unnecessary expenses.

  3. Increase efficiency: Improving the efficiency of the company's operations can also help to increase operating margin. This might involve streamlining processes, automating tasks, or investing in new technology.

  4. Expand into new markets: Expanding into new markets can help to increase revenue and operating income, which can in turn increase operating margin.

  5. Diversify the product line: Diversifying the company's product line can help to reduce reliance on any one product or market, which can make the company more resilient and help to increase operating margin.

It's worth noting that it may not be possible to increase operating margin in the short term, as some of these changes may take time to implement and have an impact on the business.


How to calculate Operating Margin?


Here is an example to illustrate how to calculate operating margin:


Let's say that Company XYZ has the following financial information for the year:


Revenue: $100,000

Cost of goods sold (COGS): $60,000

Operating expenses: $20,000

Operating income: $20,000


To calculate the operating margin, we first need to calculate the operating income. To do this, we subtract the COGS and operating expenses from the revenue:


Operating income = Revenue - COGS - Operating expenses = $100,000 - $60,000 - $20,000 = $20,000


To calculate the operating margin, we then divide the operating income by the revenue and multiply by 100 to express it as a percentage:


Operating margin = (Operating income / Revenue) * 100 = ($20,000 / $100,000) * 100 = 20%


This means that for every $1 of revenue that Company XYZ generates, it retains $0.20 as operating income.


Operating Margin vs Profit Margin


Operating margin and profit margin are both measures of a company's profitability. However, they are calculated differently and provide slightly different information.


Operating margin is calculated by dividing a company's operating income by its revenue. Operating income is the company's income from its normal business operations, before taking into account taxes and interest expenses. Operating margin is a good way to compare the profitability of different companies in the same industry, as it shows the percentage of each sales dollar that the company retains as operating income.


Profit margin, on the other hand, is calculated by dividing a company's net income by its revenue. Net income is the company's income after taking into account all expenses, including taxes and interest expenses. Profit margin shows the percentage of each sales dollar that the company retains as net income.


Both operating margin and profit margin are expressed as percentages and can be used to compare the profitability of different companies. However, profit margin is a more comprehensive measure of profitability, as it includes all expenses, while operating margin only includes expenses related to the company's normal business operations.


Operating Margin vs Gross Margin


Operating margin and gross margin are both measures of a company's profitability, but they are calculated differently and provide slightly different information.


Gross margin is calculated by dividing a company's gross profit by its revenue. Gross profit is the company's revenue minus the cost of goods sold (COGS). Gross margin is expressed as a percentage and shows the percentage of each sales dollar that the company retains after accounting for the COGS.


Operating margin, on the other hand, is calculated by dividing a company's operating income by its revenue. Operating income is the company's income from its normal business operations, before taking into account taxes and interest expenses. Operating margin is also expressed as a percentage and shows the percentage of each sales dollar that the company retains as operating income.


Gross margin is a measure of the profitability of a company's products or services, while operating margin is a measure of the overall profitability of the company's operations. Operating margin takes into account all of the company's operating expenses, while gross margin only considers the COGS.


What is a good Operating Margin?


There is no one-size-fits-all answer to what is considered a "good" operating margin, as it can vary widely depending on the industry and the specific circumstances of a company. Some industries tend to have higher operating margins than others, due to differences in the costs and revenue structures of different businesses.


As a general rule, a higher operating margin is generally considered to be better, as it indicates that the company is more profitable and is able to generate more income from its operations relative to its revenue. However, it is important to consider the context in which a company is operating, as a high operating margin may not always be attainable or sustainable.


It can be helpful to compare a company's operating margin to the industry average or to the operating margins of its competitors. This can give a sense of how the company is performing relative to others in its industry and can help to identify areas for improvement.



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