When running a business, you need to monitor profits closely —but profit isn’t a one-size-fits-all term. You need to know about several different profit margins, including operating profit margins. But what is your operating profit margin, and how does it differ from gross and net profit?
Your operating profit margin is a measure of your business’s profitability. It tells you how much profit your business generates from its operations after deducting the cost of goods sold (COGS) and operating expenses.
It differs from your gross profit margin because it doesn’t include other income or expenses, such as interest on loans, return on investments, or taxes.
On the other hand, net profit is what’s left of your profit after deducting all expenses, including taxes.
Operating profit is simply measuring how much your business makes from its operations, ignoring other financial aspects.
It’s important to know your operating profit margin because it indicates how efficient your business is. A high margin means you’re generating much profit from your operations, and your business is running smoothly. A low margin could mean you’re not selling enough or your operating expenses are too high.
Calculating your operating profit margin is the first step in working out your operating profit.
To do this, you need to know your business’s total revenue and cost of sales, as well as its operating expenses.
Operating expenses include rent, wages, utilities, and insurance.
Once you have this information, you can calculate your operating profit by deducting your cost of sales and operating expenses from your total revenue.
For example, let’s say your business had total revenue of $100,000 last year. The cost of goods sold was $50,000, and the operating expenses were $30,000. This would give you an operating profit of $20,000.
Next, divide your operating profit by your total revenue and multiply by 100 to calculate your margin. In this example, your operating profit margin would be 20%.
In summary, the formula for working out your operating margin is:
Operating Profit ÷ Total Revenue x 100 = Operating Profit Margin %
It can be very helpful to compare your operating profit margin against your gross and net profit margins.
Your operating margin will usually be lower than your gross profit margin because it excludes other income forms, such as interest or investments.
However, it should be higher than your net profit margin because it doesn’t consider all expenses, including taxes.
If your operating margin is lower than your gross and net margins, it could be a sign that your business is inefficient or that your operating expenses are too high.
You should also compare your operating profit margin year-on-year because a decline could indicate your business is becoming less profitable.
There are a few different things that can cause your operating profit margin to increase.
If your business’s revenue increases but the cost of sales and operating expenses stays the same, your margin will increase.
You can also boost your margin by reducing your sales costs or operating expenses. For example, if you negotiate better terms with suppliers or find ways to reduce your utility bills, your margin will increase.
If your business’s revenue decreases but the cost of sales and operating expenses stays the same, your margin will fall.
However, if you have to pay more for raw materials or your rent goes up whilst your revenue remains the same, your margin will decrease.
It’s essential to keep track of all your business’s financial metrics, including operating profit margin.
Understanding your operating profit margin can give you a good indication of how efficient and profitable your business is. You can also use it to compare your performance against other businesses in your industry.
Operating profit margins vary depending on the industry you’re in. Some industries are naturally more profitable than others, so compare your margin to businesses in the same sector to get a more accurate idea of how you’re faring.