Operating Profit Margin: Formula and How To Calculate ItReading Time: 2 minutes
The operating profit margin (OPM) should be a key performance indicator if you aim to sustain and grow your business.
From tracking your expenses to the cost of running your business, you can make informed cost-cutting decisions where necessary and improve profitability.
What is operating profit margin?
It is the profit you realize after subtracting the cost of goods sold (COGS) and operating expenses from the revenue generated in an accounting period.
You can also obtain it by subtracting operating expenses from the gross profit.
To express the margin in percentage, the resulting value is multiplied by 100.
Let’s look at the…
Formula for Operating Profit Margin
You first need to find the gross profit, subtract the operating expenses, and then divide it by the Total revenue.
Revenue – Cost of Goods Sold (COGS)
Then, OPM =
Operating Income (Gross Profit – Operating Expenses) / Revenue x 100
The operating income is the difference between gross profit and operating expenses. It is also called “Earnings Before Income and Taxes” or EBIT.
How to calculate it with an example
For example, look at the financial data of Ariana Drande’s Fruit Juice company.
- Revenue – $1,000,000
- COGS – $400,000
- Research expenses – $20,000
- Administrative costs – $330,000
First, calculate the Gross profit:
$1,000,000 – $400,000 = $600,000
Then, the operating margin would be:
$600,000 – ($20,000 + $330,000) / $1,000,000 * 100
Ariana Drande’s fruit juice company generated a 25% operating profit margin in the accounting year.
Tip: 15% or more is considered a good margin for most businesses.
What does it tell you?
A higher operating margin means that your business is financially sound and is likely to sustain and grow operations.
On the other hand, a low operating margin could mean your business needs better cost management, which could affect long-term goals.
Using the operating margin, you can compare profitability from two different accounting periods to determine an increase/decrease in profitability.
You can also compare your company with competitors in the same industry.
Investors use the operating margin as an essential metric for investing in a company.
Final thoughts – how to increase operating profit margin
A low operating margin could mean your business’s operating and non-operating costs are too high.
Since the operating margin measures your company’s profitability, a low margin would suggest a poor financial position.
To increase the margin, you should decrease operating expenses and the cost of goods sold. An uptrend in gross profit margin will positively affect your operating margin.