The operating margin ratio is a financial metric that measures the percentage of a company’s revenue left over after covering operating costs, indicating its profitability from core business operations.

Primary Implication

Operational inefficiencies show up in a declining Operating Margin Ratio caused by anything from nonproductive labor to wasted materials to paying too much for any expense will leave a company at a cost disadvantage.

Fail to eliminate the inefficiency, and you will either have to increase your prices to make a profit or be driven out of business by your competition, which doesn’t waste money.

Overview

Understanding Operating Margin:  A Key Profitability Metric

Operating margin is a way to measure how much money your business makes from its core operations.  It tells you what portion of each sales dollar is left over as profit after you’ve paid all the costs of doing business.

Think of it like this:

You sell a product for $1.  After paying for things like materials, labor, and marketing, you have $0. 20 left.  That’s your operating profit, and your operating margin would be 20%.

Here’s the Operating Margin formula:

(Gross Profit – Depreciation – Amortization) / Net Sales = Operating Margin

Why is Operating Margin important?

• It shows how efficiently you manage costs.  A higher margin means you’re keeping more of your sales revenue as profit.
• It indicates the financial health of your core business.  A strong operating margin means your business is profitable and sustainable.
• It helps you compare your performance to other companies.

What does your Operating Margin tell you?

• Higher margin = Stronger performance:  You’re good at controlling costs and generating profits.
• Lower margin = Potential problems:  You may need to find ways to cut costs or increase revenue.

Key takeaways:

• Track your operating margin over time to see trends and identify potential issues.
• Compare your margin to industry averages to see how you stack up against competitors.
• Focus on improving your operating efficiency to increase your profitability.