Typically, an operating profit margin of a company should be compared to its industry or a benchmark index like the S&P 500. For example, the average operating profit margin for the S&P was roughly 11% for 2017. A company that has an operating profit margin higher than 11% would have outperformed the overall market. However, it's important to take into consideration that average profit margins vary significantly between industries.

Operating profit margin is one of the key profitability ratios that investors and analysts consider when evaluating a company. Operating margin is considered to be a good indicator of how efficiently a company manages expenses because it reveals the amount of revenue returned to a company once it has covered virtually all of both its fixed and variable expenses except for taxes and interest.

What Does Operating Profit Margin Tell Investors And Business Owners

The operating profit margin informs both business owners and investors about a company's ability to turn a dollar of revenue into a dollar of profit after accounting for all the expenses required to run the business. This profitability metric is calculated by dividing the company's operating income by its total revenue. There are two components that go into calculating operating profit margin: revenue and operating profit.

Revenue is the top line on a company's income statement. Revenue or sometimes referred to as net sales reflects the total amount of income generated by the sale of goods or services. Revenue refers only to the positive cash flow directly attributable to primary operations. 

Operating profit sits further down the income statement and is derived from its predecessor, gross profit. Gross profit is revenue minus all the expenses associated with the production of items for sale, called cost of goods sold (COGS). Since gross profit is a rather simplistic view of a company's profitability, operating profit takes it one step further by subtracting all overhead, administrative and operational expenses from gross profit. Any expense necessary to keep a business running is included, such as rent, utilities, payroll, employee benefits, and insurance premiums. 

How Operating Profit Margin Is Calculated

By dividing operating profit by total revenue, the operating profit margin becomes a more refined metric. Operating profit is reported in dollars, whereas its corresponding profit margin is reported as a percentage of each revenue dollar. The formula is as follows:

One of the best ways to evaluate a company's operational efficiency is to view the company's operating margin as it changes over time. Rising operating margins show a company that is managing its costs and increasing its profits. Margins above the industry average or the overall market indicate financial efficiency and stability. However, margins below the industry average might indicate financial vulnerability to an economic downturn or financial distress if a trend develops. 

Operating profit margins vary greatly across different industries and sectors. For example, average operating margins in the retail clothing industry run lower than the average operating profit margins in the telecommunications sector. Large, national-chain retailers can function with lower margins due to the massive volume of their sales. Conversely, small, independent businesses need higher margins in order to cover costs and still make a profit.

Example of Operating Profit Margin

Apple Inc. (AAPL)

Apple reported an operating income number of roughly $61 billion (highlighted in blue) for the fiscal year ended September 30, 2017, as shown from their consolidated 10K statement below. Apple's total sales or revenue was $229 billion for the same period.

As a result, Apple's operating profit margin for 2017 was 26.6% ($61/$229). However, the number by itself doesn't tell us much until we compare it to prior years. 

  • 2017 Operating margin = 26.6% ($61/$229).
  • 2016 Operating margin = 27.9% ($60/$215).
  • 2015 Operating margin = 30.0% ($71/$234).

By analyzing multiple years, we can see that a trend has developed over the past three years where Apple's operating margins have fallen by 3.4% since 2015. Analysis of a company's operating margin should focus on how it compares to its industry average and its closest competitors, along with whether the trend of the company's margin is generally increasing or decreasing year by year.

The Bottom Line

A consistently healthy bottom line depends on rising operating profits over time. Companies use operating profit margin to spot trends in growth, but also to pinpoint unnecessary expenses to determine where cost-cutting measures can boost their bottom line. To gauge a company's performance relative to its peers, investors can compare its finances to other companies within the same industry. However, this metric is also useful in the development of an effective business strategy as well as serving as a comparative metric for investors.

For more financial analysis, please read How The Income Statement And Balance Sheet Differ?

  1. Profit margin versus operating margin: What's the difference?

    There are some distinctions between profit margin and operating margin. Both measure efficiency of a firm, but one takes ... Read Answer >>
  2. What is the formula for calculating profit margins?

    Learn about gross, operating and net profit margins, how each is calculated and how they are used by businesses and investors ... Read Answer >>
  3. What is a good operating margin for a business?

    Read about what it means to have a good operating margin and why that answer depends heavily on competitive and historical ... Read Answer >>
  4. Why Could A Company Have A Negative Gross Profit Margin?

    There are several reasons why a company might experience a loss in gross margins including poor marketing, ineffective pricing ... Read Answer >>
  5. What is the difference between revenue and cost in gross margin?

    Discover the differences between revenue and cost in gross margin, along with an explanation of various measures of profitability. Read Answer >>
Related Articles
  1. Investing

    A Look At Corporate Profit Margins

    Take a deeper look at a company's profitability with the help of profit margin ratios.
  2. Investing

    Gross, Operating and Net Profit Margins

    A company’s income statement includes the company’s gross, operating and net profits.
  3. Investing

    Apple's 5 Most Profitable Lines of Business (AAPL)

    Learn about how Apple generates its profits. It breaks its results by geographic region, with all showing year-over-year improvement.
  4. Investing

    Understanding profit metrics: Gross, operating and net profits

    Rather than relying solely on a company's net profit figures, seasoned investors will often look at gross profit and operating profit as well.
  5. Trading

    Margin Trading

    Find out what margin is, how margin calls work, the advantages of leverage and why using margin can be risky.
  6. Investing

    The Gross Margin

    A business's "gross margin" is a rough gauge of how profitable its operations are. It measures how much sales revenue the company retains after all of the direct costs associated with making ...
  7. Investing

    Is Net Income The Same As Profit?

    Net income and profit both deal with positive cash flow, but there are important differences between the two concepts.
  8. Insights

    Do Declining Corporate Margins Point To Recession in 2016?

    Learn how declining profit margins have foretold nearly every recession of the past 50 years, and analyze whether they may signal economic contraction in 2016.
  1. Margin

    Margin is borrowed money that is used to purchase securities. ...
  2. Gross Margin

    A company's total sales revenue minus its cost of goods sold, ...
  3. Profit

    A financial benefit that is realized when the amount of revenue ...
  4. Profitability Ratios

    A class of financial metrics that are used to assess a business's ...
  5. Gross Profit Margin

    A gross profit margin is a financial metric used to assess financial ...
  6. EBITDA Margin

    EBITDA margin looks at operating profitability as a percentage ...
Hot Definitions
  1. Investment Advisor

    An investment advisor is any person or group that makes investment recommendations or conducts securities analysis in return ...
  2. Gross Margin

    A company's total sales revenue minus its cost of goods sold, divided by the total sales revenue, expressed as a percentage. ...
  3. Inflation

    Inflation is the rate at which prices for goods and services is rising and the worth of currency is dropping.
  4. Discount Rate

    Discount rate is the interest rate charged to commercial banks and other depository institutions for loans received from ...
  5. Economies of Scale

    Economies of scale refer to reduced costs per unit that arise from increased total output of a product. For example, a larger ...
  6. Quick Ratio

    The quick ratio measures a company’s ability to meet its short-term obligations with its most liquid assets.
Trading Center