Operating margin: Meaning, formula and examples
Operating margin helps business owners measure how much profit their company is making from its main business operations. Understanding this metric is important, as it shows business efficiency and profitability after covering operating expenses.
Keep reading to learn more about operating margins, including how they’re calculated and a few examples.
What you’ll learn:
- Operating margin helps business owners understand how profitable their company is after all operating expenses have been paid.
- It’s important to focus on comparing the operating margins of businesses within the same industry that have similar annual sales and operating expenses.
- Other financial metrics should be taken into account to get a true picture of a business’s overall financial health and profitability.
What is operating margin?
Operating margin is a key indicator of a business’s financial health. Sometimes known as return on sales (ROS), operating margin lets a business owner know how much revenue is left after all operating expenses have been covered. Understanding your operating margin can help you make better decisions for your business.
How to calculate operating margin
Operating margin is calculated using information from your business’s income statement, such as the company’s revenue, operating expenses and cost of goods sold (COGS).
Once you have that data, you’ll then calculate operating income, also known as earnings before interest and taxes (EBIT), by subtracting operating expenses and COGS from gross profit. Then, divide the operating income by the corresponding revenue to get the operating margin, which is shown as a percentage.
Operating margin formula
The formula to calculate operating margin is:
Operating Margin = Operating Income ∕ Revenue
Operating margin is calculated by dividing the operating income, which includes COGS and operating expenses like rent, utilities, employee salaries and other administrative costs, by revenue. A higher operating margin could indicate that the company is more efficient at turning sales into profit.
For example, if a company makes $1 million in revenue and has $400,000 in operating expenses, this leaves a profit of $600,000. To calculate the operating margin, you would divide the $600,000 by $1,000,000 to get an operating margin of .6, or 60%.
Benefits and limitations
Operating margin is beneficial for a business owner because it shows how efficiently their company is running. It also helps you understand how much profit you’re keeping from every sale after covering all your operating expenses.
However, there are some limitations to keep in mind. These include:
- Differences in industries. Operating margin is more useful when you compare your business with a similar company in your industry that has comparable annual sales. When businesses in different industries with varying operating expenses and sales are compared, the operating margins will be vastly different too.
- Only considers operating expenses. Operating margin can be a great way to get an overall view of your company’s financial health. However, it doesn’t take other expenses like taxes and interest into consideration. You could better measure profitability by using earnings before interest, taxes, depreciation and amortization (EBITDA) as a tool instead.
- Doesn’t include other metrics. Other metrics like gross profit margin, net profit margin and cash flow should also be considered when determining the financial health of your business. Including these metrics can help you account for all expenses, both operating and nonoperating.
Examples
Here’s a look at the operating margin of three fictional companies to give you a better understanding of how it’s calculated and how changes in COGS or operating expenses can impact it.
In this example, the operating profit equals the revenue minus the COGS and operating expenses. Here’s what the formula looks like:
Operating Profit = Revenue- (COGS + Operating Expenses)
To determine the operating margin percentage, divide the operating profit by revenue and multiply by 100:
Operating Margin (%) = (Operating Profit / Revenue) ✕ 100
| Company | Revenue ($) | COGS ($) | Operating expenses ($) | Operating profit ($) | Operating margin ($) |
| Flowers by Rose | 300,000 | 120,000 | 100,000 | 80,000 | 26.70% |
| Carla's Clothing | 400,000 | 220,000 | 120,000 | 60,000 | 15.00% |
| Tech Desk | 500,000 | 200,000 | 150,000 | 150,000 | 30.00% |
In this next scenario, a 10% increase in COGS reduces the operating profit and, subsequently, the operating margin. This may indicate increased costs, which could impact profitability and efficiency.
| Company | Revenue ($) | COGS ($) | Operating expenses ($) | Operating profit ($) | Operating margin ($) |
| Flowers by Rose | 300,000 | 132,000 | 100,000 | 68,000 | 22.70% |
| Carla's Clothing | 400,000 | 242,000 | 120,000 | 38,000 | 9.50% |
| Tech Desk | 500,000 | 220,000 | 150,000 | 130,000 | 26.00% |
Here’s an example of what happens if the operating expenses decrease by 15%. You’ll see an improvement in the operating margin, which means the businesses are more profitable.
| Company | Revenue ($) | COGS ($) | Operating expenses ($) | Operating profit ($) | Operating margin ($) |
| Flowers by Rose | 300,000 | 120,000 | 85,000 | 95,000 | 31.70% |
| Carla's Clothing | 400,000 | 220,000 | 102,000 | 78,000 | 19.50% |
| Tech Desk | 500,000 | 200,000 | 127,500 | 172,500 | 34.50% |
How does operating margin compare to other financial metrics?
There are several other financial metrics to consider when evaluating your business’s profitability and efficiency. Here are a few:
| Metric | Description | Formula | Key differences from operating margin |
| Gross margin | The percentage of revenue after subtracting costs related to production and distribution. | Gross margin = (Revenue − COGS ∕ Revenue) ✕ 100 | Only considers direct costs, like the COGS, and doesn’t take other expenses like rent and payroll into account. |
| Net margin | Accounts for all costs, including operating and nonoperating expenses, interest and taxes. | Net margin = (Net Profit ∕ Revenue) ✕ 100 | A more comprehensive profit metric than operating margin—it reflects a company’s true bottom line. |
| EBITDA margin | Measures overall operating profitability and assesses cash flow, measuring overall earnings before interest, taxes, depreciation and amortization. | EBITDA margin = (EBITDA ∕ Revenue) ✕ 100 | While EBITDA also measures a business’s overall profitability, it may not consider other costs like capital investments. |
In general, net margin is considered the best way to measure a business’s overall profitability. It accounts for all the expenses associated with running the company, including taxes and debt.
What is a good operating margin for a company?
What qualifies as a good operating margin can vary across industries. For example, comparing the operating margins of businesses in different industries, such as a bakery and a technology company, wouldn’t be very helpful, as their business models, marketing plans, pricing structures and operating expenses could differ significantly.
What’s more useful is to learn how your business compares to the competition within your industry. This way, you can get a better picture of how efficiently your business is generating profits from sales. Generally speaking, a higher operating margin is better, as it indicates that your company is operating more efficiently and generating more profits.
Here’s an example using a sample technology company, Best Tech, and five of its competitors:
| Company | Operating margin |
| Best Tech | 34.2% |
| Technology ABC | 23.4% |
| Fittech | 20.5% |
| ShopTech | 17.4% |
| Power Technology Services | 13.5% |
Best Tech retains 34.2 cents in operating profit for every $1 in revenue it generates, meaning it’s more efficient than its competitors at converting sales into profits after covering operating expenses. But remember that these figures can change over time due to factors like fluctuations in revenue and operating expenses.
Key takeaways
Understanding how to calculate operating margin can help business owners measure their company’s profitability and efficiency. Comparing your business’s operating margin with similar companies in your industry can help you see how you stack up against the competition. But keep in mind that to get a complete picture of your business’s financial health, operating margin should be used alongside other financial metrics.
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