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Operating margin and profit margin both measure the efficiency of a firm by comparing profits against costs at three different spots on an income statement. On their own, these margins do not tell much of a story, but they are very useful when compared to past periods or to competitor firms in the same industry.

The differences between profit margin and operating margin can be telling and can help a firm identify potential areas of waste.

What Is Profit Margin?

There are two types of profit margin: gross profit margin and net profit margin. Gross profit margin reflects the relationship between gross sales revenue and cost of goods sold, ignoring other variables that may have less to do with selling merchandise. This is the most basic profit margin calculation, and it provides some estimate of a company's ability to control or minimize production costs.

Net profit margin takes into consideration the costs of taxes and interest payments, and it provides a more detailed view of financial health than gross profit margin.

Both metrics highlight how much of each dollar in revenue is kept as earnings, and they can be very useful in comparing companies.

What Is Operating Margin?

Operating margin takes a wider look at costs than at the profit margin. By taking into account variable costs, operating margin is a better reflection of the effectiveness of the company's overall pricing strategy. It goes a step further by indicating the amount of revenue a company retains after factoring in all of its operational or overhead costs; in other words, its operating expenses as a company beyond the amount directly spent on goods or parts required to manufacture the company's products.

Operational expenses include administrative costs, salaries, property or building costs, depreciation and all costs associated with marketing the company's products.

Basically, operating margin includes all expenses except for interest paid on outstanding debt and all taxes the company is liable for paying.

Comparing Operating and Profit Margin

If there is a huge discrepancy between a company's profit margin (particularly its gross margin) and its operating margin, it suggests that the company is more efficient in creating and selling its products, but perhaps less efficient in managing training, administration, research or other day-to-day business costs.

Operating margin can also be helpful in identifying areas where a company may be able to reduce costs, and as a result, increase its profit margin.

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