The operating profit margin is the profit that a business earns strictly from its operating activities, and is usually calculated on a before-tax basis.
The basic calculation is:
|-||Cost of goods sold (such as direct materials, direct labor, and overhead)
|-||Selling and administrative expenses|
|=||Operating profit (loss)|
The operating profit is then divided by revenues to arrive at the operating profit margin.
For example, ABC Company has revenues fo $10 million and an operating profit of $1.5 million. This is an operating profit margin of 15% ($1.5 million operating profit / $10 million revenues).
The operating profit margin may be more important than net profit, since it reveals the financial viability of the core business before any extraneous financial or tax-related effects. It is particularly useful to track this item on a historical trend line to see if there are any long-term changes that management should be aware of. You should also track it in comparison to the average figure for the industry in which you operate, and against key competitors, to see if your core business is competitive.
The expenses included in the calculation of the operating profit margin are comprised of both variable and fixed expenses. This calculation does not necessarily result in a subtotal for a contribution margin (which is derived from revenues minus variable expenses), with fixed costs listed below the contribution margin. Instead, any presentation format can be used. The key point is that non-operating expenses are excluded from the calculation; instead, they are listed as a deduction from the operating profit margin to arrive at the net profit margin.
The expenses not included in the calculation of the operating profit margin include:
- Income taxes
- Interest expense
- Interest income
Another definition of the operating profit margin is that it is the same as the gross margin; which is revenues less the cost of goods sold.
The operating profit margin is also known as the operating income margin, or earnings for income and taxes (EBIT).