Operating margin measures the percentage of revenue a company keeps as operating profit. This is an important metric because it indicates to investors the profitability of a business and offers a convenient way to compare competing businesses or different industries.
What is operating margin?
To understand operating margin, sometimes called operating profit margin, first let's define operating profit. Operating profit equals revenue minus the cost of goods sold and operating expenses, which typically include selling, general, and administrative costs; sales and marketing; research and development; and depreciation and amortization. EBIT, or earnings before interest and taxes, is sometimes used as stand-in terminology for operating income.
Operating margin differs from net profit margin, which is the bottom line figure, because net profit subtracts for expenses like interest and taxes in addition to non-core business activities like gains or losses on investments and revaluations of debt. Because operating margin is much more consistent across reporting periods than net profit margin, it's a better reflection of the strength of the underlying business.
Gross margin, also distinct from operating margin, is another important profitability ratio investors should know. Gross margin is the measure of gross profit divided by revenue, with gross profit equal to revenue minus the cost of goods sold.
How to calculate operating margin
The simple equation to calculate operating margin is:
Operating Margin = (Operating Income / Net Sales) x 100
Revenue | $111.4 billion |
Cost of Goods Sold | $67.1 billion |
Gross profit | $44.3 billion |
Gross margin | 39.8% |
Operating expenses | |
Research and development | $5.2 billion |
Selling, general, and administrative expenses | $5.6 billion |
Operating profit | $33.5 billion |
Operating margin | 30.2% |
In the example above, Apple's operating margin of 30.2% is found by dividing its operating profit of $33.5 billion by its revenue of $111.4 billion and multiplying that amount by 100. The company's operating margin is lower than its gross margin because operating margin accounts for fixed expenses like research and marketing that do not vary with manufacturing output.
As you can see, Apple's operating margin is phenomenal at more than 30% and just 9.6% below its gross margin. This operating margin shows the strength of the company's business and illustrates why it's one of the most valuable companies in the world.
Related investing topics
About the Author
