A:

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 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.

RELATED FAQS
  1. What is the difference between gross margin and operating margin?

    Understand the difference between gross margin and operating margin in relation to evaluating a company's overall profitability ... Read Answer >>
  2. Why does operating profit exclude interest revenues and expenses?

    Understand the purpose of examining a company's operating profit margin and why interest revenues and expenses are not included ... Read Answer >>
  3. 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 >>
  4. 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 >>
  5. What are the main reasons for why there could be a negative gross profit margin and ...

    Find out how to calculate a company's gross profit margin, why a firm might experience a negative margin and how to interpret ... Read Answer >>
  6. How much should my profit margins be?

    Understand some of the major factors you need to consider before you set a target profit margin on the merchandise for your ... 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

    The Difference Between Gross and Net Profit Margin

    To calculate gross profit margin, subtract the cost of goods sold from a company’s revenue; then divide by revenue.
  3. Managing Wealth

    What's a Good Profit Margin for a Mature Business?

    How to determine if the amount you clear dovetails with the competition.
  4. Trading

    Margin Trading

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

    Profitability Indicator Ratios

    Learn about profit margin analysis, effective tax rate, return on assets, return on equity and return on capital employed.
  6. Financial Advisor

    Margin Investing Gets A Bad Rap, But For The Thrill-Seeker, It's Worth It

    Investing on margin can be profitable but it's a risky play that needs care.
  7. Investing

    Analyzing Operating Margins

    Learn how to analyze operating margins and how to put this aspect of equity analysis to work.
RELATED TERMS
  1. Profit Margin

    Profit margin is a profitability ratios calculated as net income ...
  2. Marginal Profit

    Marginal profit is the profit earned by a firm or individual ...
  3. Margin

    1. Borrowed money that is used to purchase securities. This practice ...
  4. Gross Margin

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

    Net Margin is the ratio of net profits to revenues for a company ...
  6. Operating Margin

    Operating margin is a measure of a company's profitability, and ...
Hot Definitions
  1. Initial Public Offering - IPO

    The first sale of stock by a private company to the public. IPOs are often issued by companies seeking the capital to expand ...
  2. Cost of Goods Sold - COGS

    Cost of goods sold (COGS) is the direct costs attributable to the production of the goods sold in a company.
  3. Profit and Loss Statement (P&L)

    A financial statement that summarizes the revenues, costs and expenses incurred during a specified period of time, usually ...
  4. Monte Carlo Simulation

    Monte Carlo simulations are used to model the probability of different outcomes in a process that cannot easily be predicted ...
  5. Price Elasticity of Demand

    Price elasticity of demand is a measure of the change in the quantity demanded or purchased of a product in relation to its ...
  6. Sharpe Ratio

    The Sharpe ratio is the average return earned in excess of the risk-free rate per unit of volatility or total risk.
Trading Center