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Defintion
Operating margin is a financial metric that measures the profitability of a company’s core operations.
What is operating margin?
Operating margin represents the percentage of revenue that remains after deducting the direct costs. In essence, it shows how much profit a company generates from its primary business activities.
Operating margin is calculated using the following formula:
Operating margin = (operating Income / revenue) x 100
A higher operating margin indicates that a company is better at managing its costs and generating profit from its core operations. Conversely, a lower margin may indicate inefficiencies or a highly competitive industry.
Check out our handy operating margin calculator to make the calculation easier.
It is a key metric for comparing the financial performance of different companies within the same industry, as it provides insights into how efficiently companies manage their costs.
Factors affecting operating margin:
- Pricing strategy: The prices at which a company sells its products or services can significantly impact operating margin.
- Cost of goods sold (COGS): Managing the cost of producing or acquiring goods and services is crucial for profitability.
- Operating expenses: Efficient management of these costs can lead to higher operating margins.
- Economies of scale: Larger companies often have the potential to achieve economies of scale, which can positively impact operating margin.
- Industry and market conditions: Different industries have varying average operating margins.
Investors often analyse operating margin to assess a company’s ability to generate profit from its core operations. A consistent and healthy operating margin can be a positive sign for potential investors.
Example of operating margin
Let’s say Company XYZ has generated ₦1,000,000 in revenue from its business operations. After deducting all operating expenses, the company has an operating income of ₦300,000.
Now we can calculate the operating margin for Company XYZ:
Operating margin = (₦300,000 / ₦1,000,000) x 100% = 30%
Therefore, Company XYZ’s operating margin is 30%. This means that for every NGN of revenue generated, the company retains 30 kobo as operating profit after covering all operating expenses.
