Calculate and Interpret Operating Margin

By Stock Research Pro • August 21st, 2009

The operating margin is a ratio used to measure the proportion of a company’s revenue that is left after paying the variable costs associated with production. These costs can include labor (wages), raw materials, general and administrative expenses, advertising and more. Analyzing a company’s operating margin can help understand its operating efficiency and its pricing strategy. A company with a healthy operating margin will be able to pay its fixed costs.

Calculate the Operating Margin

The formula for operating margin can be written as:

Operating Margin = Operating Income / Net Sales

The company’s operating income is its revenue minus the operating expenses it incurs over a specified time period, typically one quarter (three months) or a full year. As you can see from the formula, the measure gives analysts and investors a sense of how much a company makes (before deducting interest and taxes) for each dollar it generates in sales.

Operating margin is expressed as a percentage to measure the percentage of revenue the company generates which it can use to pay taxes and investors (both debt and equity). For stock investors, the operating margin can be useful for comparing companies; the higher the operating margin, the better. The operating margin for one company can also be reviewed over time to analyze current performance against past performance. If a company’s operating margin is increasing, it is earning more for every dollar of sales it generates.

As an example, if a company shows an operating margin of 10%, the company is making $0.10 for every sales dollar it generate (before deducting interest and taxes).

The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax advisor.

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