How to Define Operating Margin

Operating Margin is an important measurement a company uses in evaluating its financial performance. Operating Margin measures a company’s profit after Costs of Goods and Operating Expenses.Higher Operating Margin is generally preferred. It provides the company with a financial cushion to invest back into the firm as well as pay taxes, interest, and ultimately shareholders. Operating Margin can be calculated by using Revenue, Costs and Expenses.

Instructions

Difficulty: Moderate

Things You’ll Need:

• Calculator

1. Calculate Gross Profit first. Take total Gross or Sales Revenue, minus total Sales Costs. If you sell your widget for $10, and it costs you $4 to make or buy wholesale, your Gross Profit is $6.
2. Calculate Operating Income. From your Gross Profit, deduct the costs involved in running your business, which are known as Operating Expenses. These include such expenses as General & Administrative, Sales & Marketing, and Research & Development. Gross Profit minus Operating Expenses equals Operating Income.
3. Divide your Operating Income by your Gross or Sales Revenue. If your Revenue is $10, it costs $4 to make the widget, and Operating Expenses are $3, your Operating Income will be $3. Divide $3 by $10, for a 30% Operating Margin.

Tips & Warnings

• Take a look at the Sample Income Statement in Additional Resources below to get a better sense of how different Margins fit in context with a company’s financials.