Operating margin

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:

1. Pricing strategy: The prices at which a company sells its products or services can significantly impact operating margin.
2. Cost of goods sold (COGS): Managing the cost of producing or acquiring goods and services is crucial for profitability.
3. Operating expenses: Efficient management of these costs can lead to higher operating margins.
4. Economies of scale: Larger companies often have the potential to achieve economies of scale, which can positively impact operating margin.
5. 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 pound of revenue generated, the company retains 30 pence as operating profit after covering all operating expenses.