Operating Margin

Operating profit margin measures the profitability of a company’s normal and recurring business activities. Operating profits are the profits earned before interest and taxes and extraordinary expenses. It does not include the effect of management’s financing decisions. It indicates the general health of the company’s core business. It is calculated as follows:

Operating Profit Margin = (Gross Profit – Operating expenses) / Net Sales

Nonrecurring and one-time expenses, such as cash paid out in a lawsuit settlement and goodwill write-offs are excluded from the operating margin calculation as they do not represent a company's true operating performance.

The operating margin is also considered to be an important measure of management’s efficiency. A company with lower levels of fixed costs tends to have higher operating margins. Lower fixed costs provides management with more flexibility in determining prices. Moreover, healthy a operating margin is important for any business as it provides an additional measure of safety during tough times.

Significant increases in operating margin is not necessarily a positive sign. Certain expenses like depreciation are subject to management control and can be manipulated to be seen as an increasing operating margin. Changing the depreciation methods and rates can show a temporary increase in operating margin.