Company's Financial Accounting
Operating Margin: Business's Efficiency
DEFINITION:
Operating margin (in Finnish, liiketoiminnan voittomarginaali) also referred to as return on sales (ROS), operating income margin, operating profit margin and EBIT margin. It indicates how much profit a company generates from its operations before taxes and interest are paid.
- The ratio is used to measure:
- The profitability of the operations of the business;
- or, in other words, the efficiency of a company's profit generation through its core operations.
- It demonstrates what percentage of total revenue is made up by operating income and what proportion of revenues is available to cover non operating expenses such as interest and taxes.
FORMULAS for calculations:
WHERE:
- Operating income or income from operations usually can be found on the income statement. Operating income is classified often as earnings before interest and taxes (EBIT).
Ratio can be expressed as a percentage or its equivalent decimal value
RESULT INTERPRETATION:
The higher ratio the better. High ratio indicates:
- more efficient company's operation; company is making enough money from its ongoing operations;
- more stable company's situation during slowdown and recession;
- less financial risk.
High ratio is a positive sign for potential investors, creditors and stockholders. Good operating margin will be equal or outperform the competitors in the same industry.
As Operating Margin may decline well before the company's revenue or profit decline, it is important to follow this financial metric to see in time when the company can face problems.
The result interpretation and comparison are reasonable to be made among industry competitors, as ratios vary widely by industry.
EXAMPLE:
A company's operating margin is equal to 15%:
Thus, for every euro of income, only 15 cents remain after the operating expenses have been paid, and as a result only 15 cents are left over to cover the non-operating expenses.