Operating margin (OM) is defined as the ratio of operating profits to sales revenue. It represents the profits that a business makes before paying interest on its debt and tax. For example, if a retailer has sold $1,000 of goods that were acquired for a purchase price of $600, its gross margin is:
Gross margin = sales revenue – cost of goods sold
Gross margin = 1,000 – 600 = $400
For business expenses such rent, IT costs, and payroll, that amounted to $150, the operating margin is:
Operating margin = gross margin – operating expenses
Operating margin = 400 – 150 = $250
Or as a percentage,
Operating margin = margin amount/ sales revenue
Operating margin = 250/ 1000 = 25%
The above example is illustrated below:
| Sales revenue | $1,000 |
| – cost of sales | (600) |
| – operating expenses | (150) |
| = operating margin amount | $250 |
Operating margin is a good indicator of how profitable a business is. A company that has a comfortably wider and consistently higher operating margin is one that can fare remarkably well against competition (i.e., one that has a competitive edge over its competitors).
