A:

Gross margin and operating margin are two fundamental profit metrics used by investors, creditors and analysts to evaluate a company's current financial condition and prospects for future profitability. The two margins differ in regard to the specific costs and expenses included in their calculations and the different purposes they serve in providing a company with information for analysis.

What Is Gross Margin?

Gross margin, also called gross profit margin, represents the percentage of total revenue a company has left over above costs directly related to production and distribution. The percentage figure is calculated by subtracting those costs from the total revenue figure and then dividing that sum by the total revenue figure.

As a simple example, a company with $100,000 in total sales and $65,000 in direct production-related costs has a gross margin of 35%. The gross margin shows a company the percentage of total sales it has left over to cover all other costs and expenses while leaving an acceptable net profit.

What Is Operating Margin?

Operating margin additionally subtracts all overhead and operational expenses from revenues, indicating the amount of profit the company has left before figuring in the expenses of taxes and interest. For this reason, operating margin is sometimes referred to as EBIT, or earnings before interest and tax.

Operating margin is calculated with the same formula as gross margin, simply subtracting the additional costs from revenue before dividing by the revenue figure. Operating expenses include items such as wages, marketing costs, facility costs, vehicle costs, depreciation and amortization of equipment.

Comparing Gross Margin and Operating Margin

There are plenty of similarities between gross margin and operating margin. Both are representations of how efficiently a company is able to generate profit by expressing it through a per-sale basis. Higher margins are considered better than lower margins. Both can be compared between similar competitors, but not across different industries.

Since operational costs such as salaries and advertising are more easily adjusted than the usually fixed costs of production, companies scrutinize their operating expenses for ways to cut costs efficiently, thereby increasing their profit margins. The operating margin calculation, as it is done without including costs of financing or tax expenses, also provides a company with a clear indication of whether it has a solid enough profit position to take on additional financing to expand.

Operating margin is a more significant bottom-line number for investors than gross margin. Comparisons between two companies' operating margins are considered to be more telling.

Gross profit margin is almost always higher than operating margin because there are fewer costs to subtract from gross income. Gross margin offers a more specific look at how well a company is managing the resources that directly contribute to the production of its salable goods and services.

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

    Understand the difference between gross profit margin and operating profit margin, two measures of corporate profitability ... Read Answer >>
  2. Profit Margin vs Operating Margin: What the difference?

    There are some distinctions between profit margin and operating margin. They both measure efficiency of a firm but one takes ... Read Answer >>
  3. What is considered a healthy operating profit margin?

    Operating profit margin is a profitability ratio that investors use when evaluating a company. Comparing a company's margins ... Read Answer >>
  4. What is the difference between gross profit margin and net profit margin?

    Gross profit margin and net profit margin are two separate profitability ratios used to assess a company's financial stability ... Read Answer >>
  5. 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 >>
  6. 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 >>
Related Articles
  1. 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.
  2. Investing

    A Look At Corporate Profit Margins

    Take a deeper look at a company's profitability with the help of profit margin ratios.
  3. Small Business

    How Gross Margin Can Make or Break Your Startup

    Find out how your startup's gross margin can impact your business, including why a mediocre margin may spell disaster for a budding business.
  4. Investing

    Gross, Operating and Net Profit Margins

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

    Profitability Indicator Ratios

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

    1. Borrowed money that is used to purchase securities. This practice ...
  2. Gross Profit

    Gross profit is the profit a company makes after deducting the ...
  3. Gross Profit Margin

    A financial metric used to assess a firm's financial health by ...
  4. Adjusted Gross Margin

    Adjusted gross margin is a calculation used to determine the ...
  5. Profit Margin

    Profit margin is a profitability ratios calculated as net income ...
  6. Profitability Ratios

    A class of financial metrics that are used to assess a business's ...
Hot Definitions
  1. Bond

    A bond is a fixed income investment in which an investor loans money to an entity (corporate or governmental) that borrows ...
  2. Compound Annual Growth Rate - CAGR

    The Compound Annual Growth Rate (CAGR) is the mean annual growth rate of an investment over a specified period of time longer ...
  3. Net Present Value - NPV

    Net Present Value (NPV) is the difference between the present value of cash inflows and the present value of cash outflows ...
  4. Price-Earnings Ratio - P/E Ratio

    The Price-to-Earnings Ratio or P/E ratio is a ratio for valuing a company that measures its current share price relative ...
  5. Internal Rate of Return - IRR

    Internal Rate of Return (IRR) is a metric used in capital budgeting to estimate the profitability of potential investments.
  6. Limit Order

    An order placed with a brokerage to buy or sell a set number of shares at a specified price or better.
Trading Center