The operating profit margin is the profit that a business earns from its operating activities. It reveals the financial viability of the core operations of a business before any extraneous financial or tax-related effects. The basic calculation of the operating profit margin is as follows:
|-||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 percentage.
For example, ABC Company has revenues of $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).
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 the company's core business is competitive.
The expenses included in the calculation of the operating profit margin are comprised of both variable expenses 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 the following:
- Income taxes
- Interest expense
- Interest income
- Gain or loss on asset sales
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).