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Operating margin is one of the multiple profitability ratios used by investors and companies to determine how well the company is earning relative to its revenues.
The operating margin is sometimes referred to as the EBIT margin. This is because the numerator, operating revenues, is the same as EBIT, Earnings Before Interest and Taxes. Both the operating income and total revenues can be found on the company's income statement.
An example of the operating margin ratio would be to assume that a company or investor is reviewing the company's income statement. Using round numbers for simplicity, assume that the company has $20mil in revenues. The income statement lists the COGS, Cost of Goods Sold, as $10mil and the Operating Expenses at $5mil.
The gross profit would be total revenues of $20mil minus COGS of $10mil, which would be $10mil.
The gross profit of $10mil minus the operating expenses of $5mil would result in an operating income of $5mil.
Using the formula at the top of the page, the operating income of $5mil divided by total revenues of $20mil would result in a operating margin of 25%. Notice that both the direct cost of goods and the operating costs are considered. Interest and Taxes on the income statement are not considered.
Operating Margin can be used by both investors and internally by companies to review to what extent a company's revenues will become profit, or earnings, after covering its costs. Typically, multiple margin ratios may be used for this analysis.
The operating margin ratio specifically, looks at the EBIT, Earning Before Interest and Taxes. In contrast, the net profit margin will look at earnings after all expenses. Also, in contrast, the gross profit margin will look at revenues minus the costs of goods sold and not account for the additional costs associated with doing business. In other words, the gross margin only looks at the immediate earnings on the sale of the good and not the cost of operations.
As its name implies, the operating margin looks at earnings after all operation expenses. In effect, this could be considered as reviewing the company's operating efficiency.