Operating margin is a company's operating profit, also called EBIT (earnings before interest and tax), divided by its revenue, shown as a percentage. It tells you how much profit the core business keeps from each dollar of sales after paying for the goods sold and the running costs such as wages, rent and marketing, but before interest on debt and income tax. It sits between gross margin (before running costs) and net margin (after everything).
Worked example
Say Company A has revenue of $200 million. Producing what it sold cost $120 million, so gross profit is $80 million (a gross margin of 40%). Wages, rent and marketing cost another $56 million, so operating profit is $80 million minus $56 million = $24 million. Operating margin = $24 million ÷ $200 million = 0.12 = 12%. Company A keeps 12 cents of operating profit from each dollar of sales. If it then pays $4 million of interest and $5 million of tax, net profit is $15 million and net margin is 7.5%.
Why it matters
Operating margin shows how efficiently the core business turns sales into profit, and because it sits before interest and tax, it lets you compare companies with different debt levels and tax bills. Its trend over several years is often more telling than a single year: a margin that shrinks while revenue grows is a question to look into. The pitfalls are that normal levels differ hugely by industry (a supermarket and a software firm are not comparable), and that one-off items such as restructuring costs or asset sales can distort a single year.
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Frequently asked questions
Operating margin = operating profit (EBIT) ÷ revenue × 100. Operating profit is revenue minus the cost of goods sold and the operating expenses such as wages, rent, marketing and depreciation, taken from the income statement before interest and tax.
Operating margin stops before interest and income tax, so it measures the core business alone. Net margin is net profit after interest, tax and any one-offs, divided by revenue, so it also reflects how the company is financed and taxed.
There is no single good level, because it depends on the industry. Businesses that sell low-priced goods in high volume run thin margins, while software and other asset-light businesses often run much higher ones. Compare a company with its peers and with its own past years.
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