Operating Profit Margin Ratio
Operating Profit Margin Ratio is the percentage of operating profit (i.e. profit before interest and tax) relative to the revenue earned during a period.
Operating Profit Margin Ratio is also known as Operating Income Percentage and Operating Margin Ratio.
|Operating Profit Margin Ratio||=||Operating Profit||x||100%|
- Operating Profit = Net Profit + Interest Expense + Tax Expense - Other Income
= Gross Profit - Selling, General & Administrative Expenses
- Revenue is income earned from the principal business activities
ABC PLC is in the business of manufacturing stationery supplies.
The financial results of ABC PLC for the year ended 30 June 20X4 are as follows:
|Sales revenue from selling stationery||150|
|Gain on disposal of investments||30|
|General and administrative expenses||40|
|Interest expense on bank loan||10|
|Net Profit (Income Less Expenses)||55|
Operating Profit Margin Ratio will be calculated as follows:
|Operating Profit %||=||Operating Profit||x||100%|
|Operating Profit %||=||Net Profit + Interest expense + Tax expense - Other Income||x||100%|
|=||$55 + $10 + $15 - $30||x||100%|
- Gain on disposal of investments is not considered as revenue as it is not earned from the principal business activity of ABC PLC, i.e. selling stationery goods.
Operating Profit Margin Ratio is a measure of an organization's profit generation efficiency. OP Margin of 20% means that every $1 of sale earns a profit of 20 cents for the business before taking into account taxation, interest expense and other income.
The exclusion of other income, taxation and interest expense from the calculation of profit margin arguably provides a better measure for assessing the underlying financial performance of a business as compared to net profit margin ratio because it places emphasis on only the recurring profits of a business which are not affected by fluctuations caused by changes in gearing level, tax rates and one-off gains.
The difference between gross margin ratio and operating margin ratio is the inclusion of non-production overheads (i.e. selling, distribution, general and administration expenses) in the calculation of operating margin.
Analysis & Interpretation
The trend of Operating Margin Ratio should be analyzed over several periods in the context of the industry sector in which the company operates.
Generally, a higher operating profit margin is desirable as it suggests greater potential to derive profits and more cushion against any increase in competition or costs.
A change in OP Margin Ratio could be attributed to several factors as discussed below: