Understanding Operating Margin

http://www.MDTSeminar.com Operating margin is a margin ratio used to measure a company's pricing strategy and operating efficiency. Operating margin is a measurement of what proportion of a company's revenue is left over after paying for variable costs of production such as wages, raw materials, etc. It can be calculated by dividing a company’s operating income (also known as "operating profit") during a given period by its net sales during the same period. “Operating income” here refers to the profit that a company retains after removing operating expenses (such as cost of goods sold and wages) and depreciation. “Net sales” here refers to the total value of sales minus the value of returned goods, allowances for damaged and missing goods, and discount sales. Operating margin is also often known as “operating profit margin,” “operating income margin,” “return on sales” or as “net profit margin.” However, “net profit margin” may be misleading in this case because it is more frequently used to refer to another ratio, net margin. Operating margin gives analysts an idea of how much a company makes (before interest and taxes) on each dollar of sales. Generally speaking, the higher a company’s operating margin is, the better off the company is. If a company's margin is increasing, it is earning more per dollar of sales. A company’s operating margin often determines how well the company can satisfy creditors and create value for shareholders by generating operating cash flow. A healthy operating margin is also required for a company to be able to pay for its fixed costs, such as interest on debt, so a high margin means that a company has less financial risk than a company with a low margin. When determining operating margin, it is important to take into account the nature of the operating expenses you are incorporating into your calculations. Operating expenses are often considered to be either “fixed” or “variable.” Fixed operating expenses are expenses that remain steady over time, even as business activity and revenues change. Some examples of fixed expenses include rent paid for facilities and interest on debt, as these expenses are often at predetermined rates. Variable operating expenses, on the other hand, change with changes in business. One example of a variable operating expense is the cost of raw materials, as the total cost of raw materials will rise with increased demand and sales of manufactured goods.