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Operating margin is a financial metric used to evaluate a company's profitability and efficiency by measuring the percentage of revenue that is left over after deducting operating expenses.
What is Operating Margin (OM)?
Measuring the percentage of revenue remaining after subtracting operating expenses, OM is a financial metric utilized to assess a company's profitability and efficiency. It is calculated by dividing the operating income (revenue minus operating expenses) by the total revenue and then expressing the result as a percentage.
The operating margin shows how much profit a company is generating from its core operations before taking into account other income, expenses, taxes, or interest payments. A higher OM indicates that the company is earning more profit from each dollar of revenue generated, which is generally a positive sign for investors and shareholders.
Operating margin is one of the key metrics used by analysts and investors to evaluate a company's financial health and competitiveness within its industry. It can also be used to compare the performance of different companies operating in the same sector.
Key Takeaways
- Operating margin provides insight into a company's profitability by indicating how much of its revenue is generated after deducting operating expenses. A higher OM indicates that the company is generating more profit from each dollar of revenue.
- Operating margin also provides a measure of a company's operational efficiency by indicating how effectively it manages its costs and expenses.
- A high operating margin can indicate a company's financial health and sustainability. It can be a positive signal for investors and shareholders.
- While operating margin is a useful metric, it does have its limitations. It does not take into account non-operating income and expenses, such as interest, taxes, and one-time items.
Example
A software company that generates $5 million in revenue from the sale of its products and services. The company incurs $2.5 million in operating expenses, including salaries, rent, and marketing costs. Therefore, the company's operating income is $2.5 million ($5 million in revenue minus $2.5 million in operating expenses).
To calculate the OM, we divide the operating income by the total revenue and then express the result as a percentage. In this case, the OM would be 50% ($2.5 million in operating income divided by $5 million in total revenue multiplied by 100).
This means that for every dollar of revenue generated, the company is able to keep 50 cents as operating profit after accounting for all operating expenses.
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