Operating Margin Ratio: This is the profitability ratio shows that how much profit a company earned from its core operations about the total revenue. The operating margin measures a company’s profit to determine how much revenue is left after paying certain expenses.
Do you want to calculate the operating margin ratio for your company? It is easy you need to take the company’s operating income and divide it by the total revenue. The percentage that comes is the Operating Margin Ratio.
Operating Margin Ratio
Table of Contents
- Operating Margin Ratio
- How to calculate the operating margin ratio?
- Find the Cost of Goods Sold
- Formula for COGS
- Fixed Assets Depreciation
- Operating Profit Calculation Formula
- Why do we calculate Operating Profit?
- Is a higher Profit Margin better?
- What is the role of operating margin ratio is important?
- Limitations of Operating Profit
The operating profit ratio helps to find out the operating profit earned in comparison to revenue earned.
How to calculate the operating margin ratio?
To calculate the operating income you need to take the accurate amount of operating margin. The total revenue means every penny earned by the company from the sale of goods.
Find the Cost of Goods Sold
First of all, you need to calculate gross margin/ gross profit. For this, you need to subtract the direct cost of goods or services the company sells. The items include in COGS are given below.
- Labor cost
- Raw material
The cost which is directly related to the production and changes with the production it is known as a variable cost.
Formula for COGS
(Opening stock + Purchases – Closing stock)
Calculate selling, general and administrative expenses
Find out the ancillary cost of doing business. The general overhead expenses are administration, selling, and general expenses. The amount of rent paid for the office, utilities and hiring contractors ensures that your business complies with regularity requirements.
Administration expenses include the following.
- Employee benefits expenses.
- Office and warehouse rent.
Fixed Assets Depreciation
Companies need to spend money on fixed assets and R&D. So these expenses are taken from the revenue. If a company has fixed assets calculate depreciation on them.
Operating Profit Calculation Formula
Operating revenue- Cost of goods sold- Operating expenses- Depreciation- Amortisation.
Why do we calculate Operating Profit?
Operating profit is leftover money with a business to service debts, meet liabilities, the amount for dividends, taxes. That’s why it is in particular interest of the managers, investors, and creditors.
- For Managers
It provides managers a critical understanding of the efficiency behind the cost cost-controlling. One can easily compare the operating profits of last year’s cost of revenue and operating expenses.
A manager can take corrective measures to enhance the profitability of the business.
- For Investors
The investor can understand the managerial decisions via checking the operating profits. It gives an idea of how efficient a business is doing its daily activities by checking operating profits.
Is a higher Profit Margin better?
A higher profit margin is better than a lower operating margin. It is fair to say that a good operating margin is positive and increases over time. A good profit margin varies according to the business.
A high-Profit margin is a sign of better manage resources, higher efficiency, and high operating profit. Operating profit is affected by several factors like business strategy, price of raw material, and labor cost.
A Low-Profit margin ratio is a sign of improper management of resources. It shows profit indicates from operations is not enough to compare the total revenue generated from revenue.
Operating profit reveals the responsiveness and flexibility of such companies to change. Responsiveness and flexibility are crucial factors when it comes to management’s efficiency.
It is important to measure the operating profit as it is important to measure the efficiency. Higher the operating profit more important the company’s core. It includes investment income which is directly associated with core business operations.
What is the role of operating margin ratio is important?
Operating margin is vital to be calculated for the business whether it is small or large. We know the profitability with a higher operating margin that determines how well we are doing and financially sound or not.
The business which is capable of earning operating profit
Limitations of Operating Profit
- Gives profit, not profitability
Operating profit is the company’s profit measures the profits, not the profitability. Profit is an isolated figure but profitability is a metric about a company’s revenue.
- Cannot compare with other companies
An investor cannot rely on the sole profitability of a company unless it is compared with other companies. Different industries have different levels of operating profit so contrasting their profit is not an accurate measure.