What operating profit margin tells you
Operating income is what the business earns from its main activities. It starts from revenue and deducts cost of goods sold and operating expenses such as salaries, rent, marketing and depreciation. Interest, income tax and income or expenses that sit outside the core business are not deducted at this level. Revenue is net sales for the same period.
A result of 15% means 15% of revenue is left after the costs of running the business. Interest, income tax and any non-operating items still have to be accounted for before you reach net income. A negative result means an operating loss: operating expenses were larger than gross profit.
Operating income and EBIT
The two terms are often used as if they were the same. They differ when a business has non-operating income or expenses, such as investment income. Operating income, as reported on the income statement, leaves those items out. EBIT is often worked out by adding interest and tax back to net income, which keeps them in. Use operating income from the income statement, and when you compare businesses, check that each figure was built the same way.
Reading a high or low result
Operating margin reflects both pricing and cost control. Because it is measured before interest and tax, it is less affected than net margin by how a business is financed or where it pays tax, which makes it useful for comparing businesses with different levels of debt.
- A higher or rising margin can come from higher prices, lower costs, or fixed costs spread over more sales. Where a large share of costs is fixed, the margin can rise quickly as sales grow and fall just as quickly when sales drop.
- A lower or falling margin can reflect rising overheads, pressure on prices, or deliberate spending on growth, such as marketing or product development, that may pay off in later periods.
Typical levels vary widely by industry and business model. Compare the margin with earlier periods of the same business, or with similar businesses.
What the margin does not show
- It ignores interest. A business with heavy borrowing can show a high operating margin and still struggle to meet its interest payments. Interest coverage looks at that directly.
- It is based on accrual accounting, not cash. Operating income includes noncash charges such as depreciation, and it records sales when they are earned rather than when customers pay.
- One-off items, such as restructuring costs or asset write-downs, are often included in operating income and can distort a single year.
Common mistakes
- Comparing one business’s reported operating income with another’s EBIT calculated from net income.
- Taking an “adjusted” operating income figure from a results announcement and comparing it with another business’s reported figure.
- Using gross sales instead of net revenue.
- Drawing conclusions from a single year without checking for one-off charges or gains.
Related measures
Gross profit margin stops before operating expenses, so comparing it with operating margin shows how much of revenue overheads take up. Net profit margin continues past interest and tax to the bottom line. EBITDA margin adds depreciation and amortization back to earnings; EBIT vs EBITDA explains how the two earnings measures differ.