Operating Margin Ratio

Operating margin ratio or return on sales ratio is the ratio of operating income of a business to its revenue. It is profitability ratio showing operating income as a percentage of revenue.

Formula

Operating margin ratio is calculated by the following formula:

Operating Margin = Operating Income
Revenue

Operating income is same as earnings before interest and tax (EBIT). Both operating income and revenue figures can be obtained from the income statement of a business.

Analysis

Operating margin ratio of 9% means that a net profit of $0.09 is made on each dollar of sales. Thus a higher value of operating margin ratio is favorable which indicates that more proportion of revenue is converted to operating income. An increase in operating margin ratio overtime means that the profitability is improving. It is also important to compare the gross margin ratio of a business to the average gross profit margin of the industry. In general, a business which is more efficient is controlling its overall costs will have higher operating margin ratio.

Examples

Example 1: Determine the operating margin ratio of Company α given that its sales are $928,300 and its operating income is $113,200 for the month. What is the performance of the company compared to its industry which has average operating margin ratio of 10%?

Solution
Operating margin ratio = $113,200 / $928,300 ≈ 0.12 = 12%
The company is more profitable than an average firm in its industry.

Example 2: Calculate operating margin ratio from the following information:

Cost of Goods Sold$34,390
Gross Profit42,030
Other Operating Costs37,200

Solution
Step 1: Revenue = $34,390 + $42,030 = $76,420
Step 2: Operating Income = $42,030 − $37,200 = $4,830
Step 3: Operating Margin Ratio = $4,830 / $76,420 ≈ 0.063 or 6.3%

Written by Irfanullah Jan