As a rule, the operating profit of the company should be compared with the industry or underlying index like the S&P 500. For example, the average operating profit margin for the S&P was approximately 11% in 2017. The company, which has an operating profit of more than 11% would have outperformed the overall market. However, it is important to note that the average rate of return vary significantly between industries.
Operating profit margin is a key measure of profitability that investors and analysts consider when evaluating companies. Operating margin is considered a good indicator of how effectively the company manages expenses because it shows the amount of revenue returned to the company after he has covered virtually all of its fixed and variable costs, excluding taxes and interest.
What Does Operating Profit Margin Can Tell Investors And Business Owners
Operating profit margin informs business owners and investors about the company’s ability to turn one dollar of revenue per dollar of net profit after accounting for all expenses necessary to run the business. This profitability ratio is calculated by dividing operating income to its total revenue. There are two components that go into the calculation of operating profit: revenue and operating profit.
The company is located in the top row on the income of the company. Income or sometimes called net sales reflects the total amount of income generated by the sale of goods or services. The company refers only to positive cash flow directly connected with the main activity.
Operating profit sits further income is derived from its predecessor, gross profit. Gross profit is revenue minus all costs associated with the production of goods for sale, called the cost of goods sold (cogs). Since gross profit is a rather simplistic view of company profitability, operating profit takes another step forward by subtracting all overhead, administrative and operating expenses from gross profit. Any expenses needed to keep the business running, such as rent, utilities, salaries, employee benefits, and insurance premiums.
As Operating Profit Margin Is Calculated
By dividing operating profit by total revenue, operating profit becomes more refined metrics. Operating profit stated in dollars, while corresponding profit reflected as a percentage of each dollar of income. Companies with proceeds totaling $100,000 and 65% profit keeps the $ 65,000 profit after accounting for all production and operational costs. The formula is as follows:
One of the best ways to assess the effectiveness of the company’s operations is the Operating margin of the company as it changes over time. The increase in operating margins show the company that manages your costs and increasing your profits. Profitability above industry average or the market in General indicate financial efficiency and stability. However, profitability is below the industry average may indicate financial vulnerability in economic downturn or financial crisis if the trend develops.
Operating profit margin greatly vary in different industries and sectors. For example, the average level of profitability in the retail clothing industry to work with lower than average operating profit margin in the telecommunications sector. Large national chain retailers can work with lower margins due to the massive volume of their sales. Conversely, a small, independent companies need higher margins to cover costs and still make a profit.
Analysis operating margin, the company needs to focus on how it compares to its industry average and its closest competitors, along with a trend margin, as a rule, increases or decreases from year to year.
Example operating profit
Apple reported an operating profit of about $61 billion (in blue) for the fiscal year ended September 30, 2017, as is evident from their 10K consolidated statement below. Apple’s total sales or revenues amounted to $229 billion for the same period.
The result of Apple’s operating profit for 2017 was 3.75% ($229/$61). However, the number itself doesn’t tell us much until we compare it with previous years.
- 2017 Operating margin = 3.75% ($229/$61).
- 2016 Operating margin = 3.6% ($216/$60).
- 2015 Operating margin = 3.3% ($234/$71).
Analyzing several years, we see that this trend has developed over the last three years, where operating profit of Apple has been steadily improving.
A consistently healthy bottom line is dependent on growth in operating profit over time. Companies use operating profit margin to identify trends in growth, but also identify unnecessary expenses, to determine where measures to reduce costs can increase their bottom line. To evaluate the performance of the company compared to competitors, investors can compare their financials with other companies in the same industry. However, this indicator is also useful in developing an effective business strategy, and also serves as a Comparative metric for investors.