No business will have long-term viability if it fails to consistently generate a healthy Operating Income. The key to a healthy Operating Income is the strength of your Gross Profit. Your Gross Profit is a “cash quality” function reflected by Net Sales less direct and indirect costs.
When your sales cash quality is high, all you have to do is manage your overhead within an acceptable range relative to Gross Profit, and you will have healthy operating profits. Use the Operating Income Sales Productivity Throughput Ratio to confirm all of this is happening. The higher the ratio, the better you are at converting sales into profits.
Operating Income is what’s leftover from a dollar of sales after subtracting all of the costs of producing, acquiring, selling, and supporting your business. It represents what is available from each dollar of sales to pay the company’s capital providers and its taxes after all operating and overhead costs have been paid. It’s one of the best measures of managerial performance.
Operating Income Sales Productivity or Operating Margin Ratio shows how well management makes its cash available for use through its operations.
The formula for calculating Operating Income Sales Productivity is the following:
Output (Operating Profit) / Input (Net Sales)
A ratio of 0.22 means that the company is generating 22 cents in operating profit for every dollar collected and held onto from sales. A 0.12 ratio means that $0.12 in operating profit is generated for every $1.00 sold and collected.
Higher Creates Opportunity: the more money that remains after paying operating costs, the more successful the operations and stable the company.
Lower Creates Challenges: less money shows that operating activities are not sustainable when non-operating income is needed to cover operating expenses.