Operating Margin

Profitability Metric Investment Wiki — Fundamentals
Operating Margin measures how much profit a company makes on a dollar of sales after paying for variable costs of production, wages, raw materials, and administrative expenses, but BEFORE paying interest or taxes.
Quick Reference
Type Profitability Metric
Formula Operating Income ÷ Total Revenue
High Quality > 15%
Best Used For Analyzing pricing power and cost efficiency

1.0 The Formula

Basic Form

formulaOperating Margin = Operating Income (EBIT) / Total Revenue

Operating Income = Gross Profit - Operating Expenses (SG&A, R&D)

Operating Margin focuses exclusively on the core business engine. It ignores how the company chose to fund itself (taxes and interest) and focuses strictly on whether its core operations are fundamentally profitable.

Worked Example

Company Revenue Operating Income Margin
Retailer A $10 Billion $500 Million 5.0%
Software B $2 Billion $800 Million 40.0%

Retailer A must grind out ten billion in sales just to make a tiny sliver of profit (5%). Software B has an incredible margin of 40%, meaning 40 cents of every dollar they make falls straight to the bottom line.

2.0 Interpretation & Edge Cases

Companies with consistently expanding operating margins have distinct "Moats" or pricing power. They can raise prices without losing customers (like Apple), or they successfully reduce their internal costs through extreme scaling (like Amazon Web Services).

A declining operating margin is the first red flag of a failing business. It usually means competitors are forcing the company to slash its sale prices to survive, or the company has lost control of its internal administrative costs.

3.0 Related Pages

EBITDA

EBITDA and Operating Margin are closely related, though EBITDA adds back Depreciation & Amortization.