Operating margin is often referred to as return on sales or operating profit margin. It indicates how much of the operating profit is generated for each unit of net sales.
How To Calculate The Operating Margin
Net sales and operating income are other important financial indicators that calculate operating margin. A company’s income statement contains all the necessary data. Especially when conducting a comparative study, it is important to have accurate data prepared using consistent accounting methods. Companies can calculate operating margins over any period, including monthly, quarterly, or annually. Companies often calculate operating margins for specific business units and product categories. This allows them to compare the profitability of different business units.
Operating income does not include non-operating income and costs derived from non-operating activities and one-time gains and losses. For example, investment income, one-time payments, gains on the sale of assets, impairment losses on intangible assets, and financing costs are not included in operating profit. Another significant deduction from operating profit is the income tax.
The sum of all product and service sales is referred to as net sales. In an income statement, companies usually report either gross or net sales. Gross sales include both cash and credit sales, depending on the accounting system used by the company. Gross sales less returns and after-sales discounts and rebates, such as cash discounts, result in net sales. Operating profit and operating margin are calculated based on net sales.
Divide operating income by net sales and multiply the result by 100 to get the operating margin. The mathematical formula for this concept is:
Operating Margin = Operating Profit / Net Sales x 100.
What The Operating Margin Tells Us
You can determine a company’s operating margin by looking at how effectively its main business generates profit. When comparing companies, the operating margin is usually an indicator expressed as a percentage. But it is a helpful indicator. For example, it can compare a company to competitors with higher or lower revenues and operating income. When comparing operating profit margins, company size is disregarded, and it becomes apparent how much profit each company makes on each revenue unit.