What is operating profit margin and how is it calculated?

Revolut Contributor

 · June 22, 2020  · 06/22/2020

Operating profit margin is a ratio that reveals how much profit a business makes for every pound it generates in revenue, once it deducts the direct costs of achieving this revenue and the day-to-day operating costs of the business. It does not take into account any tax due nor interest owed on bank loans.

How do you calculate the operating profit margin?

Take the figure for the operating profit of a business over a given period – for instance, a quarter or a financial year –  and divide this sum by total revenue during that time. The result is then multiplied by one hundred to convert this ratio into a percentage and reveal the operating profit margin.

Operating profit margin = (Operating Profit/Revenue) x100

Using the operating profit margin formula is easier if you have access to the key figures that it relies upon – for instance, on the income statement of the business – without starting from basic principles. If not, we explain how to calculate operating profit in detail here.

In plain terms, operating profit is the figure left once a business subtracts its direct costs, also known as cost of goods sold, and all the other costs involved in running the business from its revenue. These deductions include rent, staff salaries, or allowances in the annual accounts for depreciation and amortisation of long-term assets that it owns.

The calculation does not take into account any money that enters or leaves the business through drawings, nor additional income earned through investments. This is the principal reason why the operating profit and earnings before interest and tax (EBIT) are distinct.

What is the difference between operating profit and operating margin?

The key point here is that the operating profit formula provides us with an answer that is an absolute monetary value, whereas the operating margin  – which is another way of saying operating profit margin – is a percentage. One is a specific amount of money and the other is a ratio that shows how much operating profit the business makes per pound of revenue.

Why is the operating profit margin important?

Profit margins show how efficiently a business converts its revenue into profit of different types, depending on which costs it includes in the calculation. The great thing about margin analysis is that it enables the direct comparison of different sized businesses. If this ratio is too low, or falls from one period to the next, it should consider potential cost savings.

Investors watch this particular profit margin closely because it reveals if a company’s core business is profitable, or not, before it considers non-operating items. The reason is that operating income (i.e. profit) is, by definition, more tightly focussed on the factors that are likely to be within the control of managers than some rival metrics, such as net profit.

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