Operating Margin

Operating margin

Investors and analysts can better understand a company’s financial health and make more informed investment decisions by focusing on the operating margin. In summary, operating margin is an important metric that provides valuable insights into a company’s profitability and financial performance. 

What is operating margin? 

Operational margin, commonly referred to as return on sales, is a fundamental profitability statistic that measures revenue after subtracting operating costs. After paying for variable manufacturing expenses like labour and raw materials but before paying the interest or taxes, this margin calculates the profit an organisation generates on each dollar of sales. 

Understanding the operating margin 

Operating income is also called EBIT, or Earnings before Interest and Taxes. Let’s understand operating profit first before discussing operating margin, often known as operating profit margin.  

Operating profit = revenue – the cost of goods sold and operating expenses (typically includes selling, general, and administration costs, sales and marketing, research and development, and depreciation and amortisation) 

Operating margins with high variability are a key sign of company risk. Likewise, examining a company’s historical operating margins can help determine if its performance has improved. The operating margin may be raised by improving managerial controls, resource usage efficiency, pricing, and marketing effectiveness. 

Whether monthly, quarterly, or yearly, companies may calculate operating margins throughout any period. Companies frequently calculate the operating margin for certain company divisions and product categories. In doing so, they can contrast the profitability of various corporate divisions. 

Operating margin formula 

Operating margin   

                                  operating income 

Operating margin = ————————————— x 100 

                                              revenue 

Let us look at the following example. If a corporation had US$2 million in revenue, US$800,000 in Cost of goods sold (COGS), and US$600,000 in administrative expenses, its operating profits would be US$2 million – (US$800,000 US$ + US$600,000 US$) = US$600,000.  

Thus, it would have an operating margin of US$600,000 / US$2,000,000 x 100, i.e., 30%. 

The company’s operating margin would increase to 40% if it could lower its COGS to US$600,000 by negotiating better rates with its vendors. 

Usage of operating margin 

Investors and analysts use the operating margin to evaluate a company’s financial health. Using an operating margin can help investors determine whether a company is generating enough revenue to cover its operating expenses and earn a profit.  

 However, operating margins will vary by industry. Thus, comparisons should be conducted with comparable companies in similar sectors. 

 Identifying particular areas for improvement would be possible by looking at a breakdown of operational expenses. For instance, a spike in general, selling, and administrative costs in one quarter can prompt senior management to investigate the causes of the rise and look for strategies to keep costs in check in the following periods. 

 A high operating margin indicates that a company efficiently manages its expenses and generates profits. In contrast, a low operating margin may indicate a company is struggling to cover its costs. Operating margins can help companies identify areas to reduce costs and improve profitability.  

 Overall,  is essential for investors and companies to use operating margins to evaluate financial performance and make informed decisions. 

Operating margin/profit drawbacks 

While the operating margin is an essential tool for evaluating a company’s financial health, there are drawbacks to relying solely on the operating margin as a performance indicator.  

One significant drawback is that it does not account for non-operational expenses, such as interest or taxes. Therefore, a company with high non-operating expenses or debt may have a lower operating margin.  

Additionally, the operating margin does not consider a company’s revenue growth potential, which is crucial for long-term success. To understand a company’s financial performance, it is important to consider operating margin alongside other financial metrics, such as net income, cash flow, and return on investment. 

Frequently Asked Questions

The ideal operating margin for companies is 15% or more. 10% is regarded as average. The industry a company operates in and macro trends to determine whether margins are increasing or decreasing – and are important factors when assessing a firm’s operating margin. 

  • It measures a company’s profitability. 
  • It assists with evaluating a company’s financial health. 
  • It helps in decision-making about investing in a business. 
  • It determines if the business is profitable enough to continue operating. 
  • Profit margins indicate if your expenditures are too low or too high for your industry. 
  • It provides insight into the potential for revenue growth. 
  • It can be used as a performance indicator. 

Divide operating income (profits) by sales to determine the operating margin (revenues). 

All COGS, depreciation & amortisation, and other relevant operational expenditures are subtracted from total sales to calculate operating profit. In addition to direct production costs, a company’s operating expenditures include wages and benefits, rent and related overhead costs, research and development costs, etc. 

Operating margin is a financial metric that is used to measure the profitability of a company’s operations. It is different from other profit margins in that it takes into account only the operating expenses of a company and excludes non-operating expenses such as interest and taxes.  

The operating margin is often considered a more accurate reflection of a company’s profitability than other profit margins because it provides insight into the company’s ability to control costs and generate profits through its core business activities. This metric is particularly useful for companies with high debt levels or significant non-operating expenses. 

Some high profit margin industries are: 

  • Finance with 32% 
  • Transportation with 28.90% 
  • Software (System and Application) with 19.66% 
  • Software (entertainment) with 29.04% 
  • Tobacco with 20.58% 
  • Information Services with 16.92% 
  • Computers and Peripherals with 18.72% 

Some low profit margin industries include: 

  • Car Dealerships 
  • Travel and Accommodations 
  • Home Healthcare Services 
  • Lawn and Garden Supply Stores 
  • Furniture Stores 
  • Assisted Living and Retirement Homes 

 

Related Terms

    Read the Latest Market Journal

    What is CFD? With 2 Practical Examples

    Published on May 15, 2024 74 

    In this article, you will learn what CFD (Contract for Difference) is, the costs and...

    What is ESG investing, and why is it important?

    Published on May 15, 2024 67 

    Over the last five years, Environmental, Social, and Governance (ESG) investing has evolved from being...

    What are fixed-income funds?

    Published on May 15, 2024 36 

    In the diverse world of unit trusts, various funds employ distinct investment strategies aligned with...

    Hong Kong Value Stocks Q2 2024

    Published on May 14, 2024 97 

    After a long period of sluggishness, Hong Kong market has begun to pick up. The...

    Weekly Updates 13/5/24 – 17/5/24

    Published on May 13, 2024 43 

    This weekly update is designed to help you stay informed and relate economic and company...

    The 5 Levels of Mindset to Achieve FIRE

    Published on May 9, 2024 115 

    Imagine a life where you feel financially secure, confident, and at peace. A life where...

    Weekly Updates 6/5/24 – 10/5/24

    Published on May 6, 2024 71 

    This weekly update is designed to help you stay informed and relate economic and company...

    Weekly Updates 29/4/24 – 3/5/24

    Published on Apr 29, 2024 40 

    This weekly update is designed to help you stay informed and relate economic and company...

    Contact us to Open an Account

    Need Assistance? Share your Details and we’ll get back to you

    IMPORTANT INFORMATION

    This material is provided by Phillip Capital Management (S) Ltd (“PCM”) for general information only and does not constitute a recommendation, an offer to sell, or a solicitation of any offer to invest in any of the exchange-traded fund (“ETF”) or the unit trust (“Products”) mentioned herein. It does not have any regard to your specific investment objectives, financial situation and any of your particular needs. You should read the Prospectus and the accompanying Product Highlights Sheet (“PHS”) for key features, key risks and other important information of the Products and obtain advice from a financial adviser (“FA“) pursuant to a separate engagement before making a commitment to invest in the Products. In the event that you choose not to obtain advice from a FA, you should assess whether the Products are suitable for you before proceeding to invest. A copy of the Prospectus and PHS are available from PCM, any of its Participating Dealers (“PDs“) for the ETF, or any of its authorised distributors for the unit trust managed by PCM.  

    An ETF is not like a typical unit trust as the units of the ETF (the “Units“) are to be listed and traded like any share on the Singapore Exchange Securities Trading Limited (“SGX-ST”). Listing on the SGX-ST does not guarantee a liquid market for the Units which may be traded at prices above or below its NAV or may be suspended or delisted. Investors may buy or sell the Units on SGX-ST when it is listed. Investors cannot create or redeem Units directly with PCM and have no rights to request PCM to redeem or purchase their Units. Creation and redemption of Units are through PDs if investors are clients of the PDs, who have no obligation to agree to create or redeem Units on behalf of any investor and may impose terms and conditions in connection with such creation or redemption orders. Please refer to the Prospectus of the ETF for more details.  

    Investments are subject to investment risks including the possible loss of the principal amount invested. The purchase of a unit in a fund is not the same as placing your money on deposit with a bank or deposit-taking company. There is no guarantee as to the amount of capital invested or return received. The value of the units and the income accruing to the units may fall or rise. Past performance is not necessarily indicative of the future or likely performance of the Products. There can be no assurance that investment objectives will be achieved.  

    Where applicable, fund(s) may invest in financial derivatives and/or participate in securities lending and repurchase transactions for the purpose of hedging and/or efficient portfolio management, subject to the relevant regulatory requirements. PCM reserves the discretion to determine if currency exposure should be hedged actively, passively or not at all, in the best interest of the Products.  

    The regular dividend distributions, out of either income and/or capital, are not guaranteed and subject to PCM’s discretion. Past payout yields and payments do not represent future payout yields and payments. Such dividend distributions will reduce the available capital for reinvestment and may result in an immediate decrease in the net asset value (“NAV”) of the Products. Please refer to <www.phillipfunds.com> for more information in relation to the dividend distributions.  

    The information provided herein may be obtained or compiled from public and/or third party sources that PCM has no reason to believe are unreliable. Any opinion or view herein is an expression of belief of the individual author or the indicated source (as applicable) only. PCM makes no representation or warranty that such information is accurate, complete, verified or should be relied upon as such. The information does not constitute, and should not be used as a substitute for tax, legal or investment advice.  

    The information herein are not for any person in any jurisdiction or country where such distribution or availability for use would contravene any applicable law or regulation or would subject PCM to any registration or licensing requirement in such jurisdiction or country. The Products is not offered to U.S. Persons. PhillipCapital Group of Companies, including PCM, their affiliates and/or their officers, directors and/or employees may own or have positions in the Products. Any member of the PhillipCapital Group of Companies may have acted upon or used the information, analyses and opinions herein before they have been published. 

    This advertisement has not been reviewed by the Monetary Authority of Singapore.  

     

    Phillip Capital Management (S) Ltd (Co. Reg. No. 199905233W)  
    250 North Bridge Road #06-00, Raffles City Tower ,Singapore 179101 
    Tel: (65) 6230 8133 Fax: (65) 65383066 www.phillipfunds.com