Operating profit margin shows how much profit your business generates from its core activities after direct costs and operating expenses come out. Sales alone do not tell you whether the business runs efficiently. Instead, this percentage helps you compare performance, spot cost pressure and judge whether your business model is producing enough profit from day-to-day operations.

About this episode

Profit is not a one-size-fits-all term. Different profit measures tell you different things about your business.

This episode focuses on operating margin. We look at what it means, how to calculate it, why it matters and what can affect the margin your business generates.

This measure is useful because it turns operating profit into a percentage. That makes it easier to compare performance over time, against your plans, or against similar businesses where the comparison makes sense.

Why operating margin matters

Operating margin helps you understand how efficiently your business runs.

It shows how much operating profit comes from each pound of revenue, after the business has covered cost of sales and operating expenses. Because of that, it gives a clearer picture than turnover alone.

A strong margin can suggest that the business controls costs well and generates healthy profit from core operations. A weak margin may point to low sales, high operating costs, weaker gross profit, or a mix of all three.

For the wider profit foundation, see What Is Profit? Gross Profit and Net Profit Explained.

What is operating profit margin?

Operating profit margin is operating profit shown as a percentage of revenue.

Revenue is the value of what the business sells. From that, the business deducts cost of goods sold, also called cost of sales or direct costs. Then it deducts operating expenses, such as wages, rent, utilities, insurance, marketing, bookkeeping and other running costs.

The margin then compares the operating profit figure with total revenue. This shows the percentage of sales that becomes operating profit.

Operating margin and gross profit margin

Operating margin is not the same as gross profit margin.

Gross profit margin compares gross profit with revenue. It looks at sales after direct costs, but before operating expenses.

Operating margin goes further. It includes operating expenses, so it gives a wider view of how the business performs after running costs come into the calculation.

That is why this percentage is usually lower than gross profit margin. Operating profit sits after more costs have been deducted.

For the previous step in the profit journey, see What Is Operating Profit?.

Other terms linked to operating profit

Operating profit can appear under different names.

• Operating profit: profit from core operations before interest and tax.
• Net profit: sometimes used in a similar way, depending on the context.
• EBIT: earnings before interest and tax.
• PBIT: profit before interest and tax.

These terms are closely linked, but reports may use them differently. Therefore, always check which costs have already been included and whether interest and tax still sit outside the figure.

How to calculate operating profit margin

Start by calculating operating profit.

Revenue minus cost of sales minus operating expenses equals operating profit.

Then calculate the margin.

Operating profit divided by revenue, multiplied by 100, equals operating profit margin.

That final percentage shows how much operating profit the business generates from its revenue.

Operating margin example

The episode uses a simple example to show how the calculation works.

Assume a business has £100,000 of revenue. The cost of sales is £50,000, and operating expenses are £30,000.

First, calculate operating profit:

• Revenue: £100,000
• Cost of sales: £50,000
• Operating expenses: £30,000
• Operating profit: £20,000

Next, divide the £20,000 operating profit by the £100,000 revenue. Then multiply by 100.

That gives a margin of 20%.

For a related performance-measurement episode, see Using Financial Ratios in Business.

Why context matters when judging your margin

A margin by itself does not tell the full story.

You need a benchmark, context or yardstick. Without that, the number sits in isolation and has limited value.

Good comparisons may include:

• your budget or plan
• your previous year’s margin
• earlier months or quarters
• similar parts of your own business
• similar businesses in the same sector, where the comparison is fair

Comparing a small restaurant with a large restaurant chain may not give a fair picture. Comparing a hospitality business with an aviation business makes even less sense. Different industries work with different cost structures and different margin expectations.

What affects operating margin?

Several factors can move this percentage up or down.

Revenue changes

If sales rise while operating costs stay broadly stable, the margin may improve. However, if sales fall and costs stay in place, it can decline quickly.

Cost of sales

Changes in direct costs can affect the figure. If materials, stock, delivery costs or direct labour increase, gross profit may fall. That can then reduce operating profitability.

Operating expenses

Running costs also influence the result. These can include rent, utilities, insurance, staff costs, marketing, admin and other overheads.

If these costs rise faster than revenue, profitability may come under pressure.

Investment decisions

A falling margin is not always bad news.

Sometimes, the business has chosen to invest in people, systems, infrastructure or capacity. In the short term, those decisions may increase operating expenses and reduce the margin. Over time, they may support growth and stronger results.

That is why the number needs investigation, not panic.

High margin vs low margin

A high operating margin can suggest that the business generates strong profit from its operations and controls costs well.

A low margin may suggest that sales are not high enough, costs are too high, or the business model needs closer review.

However, high and low are relative. Some industries naturally work with lower margins and high sales volumes. Others may work with higher margins and lower overheads.

For example, transport, aviation and shipping may have lower margins but very large turnover. Service-based businesses, consulting businesses and training companies may generate higher margins because their overhead base can be more modest.

Using margin to improve performance

This measure helps you ask better questions about performance.

• Are sales moving in the right direction?
• Are direct costs reducing gross profit?
• Are operating expenses too high?
• Is the business becoming more efficient?
• Are recent investments affecting short-term results?
• How does this year compare with last year?
• How does actual performance compare with the budget?

These questions help turn the percentage into a management tool.

Why your accounting system matters

To calculate the margin properly, you need reliable numbers.

Your accounting system should make it easy to extract revenue, cost of sales and operating expenses. If those numbers are hard to find, your finance system may need attention.

Good digital records make it easier to calculate metrics, compare results and monitor performance. The episode also links this to planning tools such as BudgetWizz and accounting systems such as Xero.

For help with the wider picture, see Understanding Your Financial Statements.

FAQs about operating profit margin

What is operating profit margin?

Operating profit margin is operating profit shown as a percentage of revenue. It shows how much profit the business generates from core operations after direct costs and operating expenses come out.

How do you calculate operating margin?

You calculate it by dividing operating profit by revenue and multiplying the result by 100.

Is operating margin the same as gross profit margin?

No. Gross profit margin looks at revenue after direct costs. Operating margin also includes operating expenses, so it gives a wider view of business performance.

What is a good operating margin?

A good margin depends on the business, sector, size and cost structure. Compare your result with your own budget, previous results and similar businesses where the comparison is meaningful.

Why does the margin change?

The margin can change because of sales movement, direct cost changes, operating expense changes, productivity, efficiency or investment decisions.

Episode Timecodes

• 00:00 – Why profit matters in every type of business
• 00:23 – What the episode covers: calculation, meaning and margin influences
• 00:41 – Relative numbers and absolute values
• 01:26 – What operating margin tells you
• 01:45 – Cost of goods sold, direct costs and operating expenses
• 02:06 – Operating profit, gross profit margin, EBIT and PBIT
• 03:02 – Why the margin matters
• 03:48 – Why benchmarks and context are essential
• 04:36 – How to calculate operating profit
• 05:34 – Example using revenue, cost of sales and operating expenses
• 06:16 – Calculating the 20% operating margin
• 06:34 – How to judge whether a margin is good or bad
• 07:20 – Why operating margin is lower than gross margin
• 07:48 – What can improve the margin
• 08:08 – Why margins may decline
• 08:56 – Revenue, cost of sales and operating expenses as key drivers
• 09:16 – Comparing margins with caution
• 10:27 – Accounting systems, BudgetWizz and Xero
• 10:49 – Final thoughts on performance insight

Related episodes

• What Is Operating Profit?
• Gross Profit Explained: How to Calculate Gross Profit, Margin and Markup
• Using Financial Ratios in Business

Key takeaway

Operating profit margin helps you see how efficiently your business turns revenue into operating profit. It takes the operating profit figure and expresses it as a percentage, making it easier to compare performance over time.

The number becomes most useful when you compare it with your plan, your past results and meaningful benchmarks. Then it can point you towards cost pressure, sales issues, efficiency gains or investment effects.

Plan it, Do it, Profit.

“Profit isn’t a one-size-fits-all term.”

Further Support

The I Hate Numbers podcast helps business owners understand profit, operating margin, gross margin, pricing, costs, cash flow, tax and financial performance in a practical way. We simplify business finance so you can make better decisions and feel more confident with your numbers.

If you need help understanding operating margins, reviewing costs, improving profitability or building better management reports, you can contact us for an initial chat.

You can also use the free online business calculators to support your profit and pricing decisions.

For more practical finance and tax support, visit the I Hate Numbers YouTube channel, or listen and follow on Apple Podcasts.

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When running your business, you need to keep an eye on your profits. Whether your business is a private business, a social enterprise, or not-for-profit, keeping an eye on profits is important. And profit isn't a one-size-fits-all term. There are several different profits that you need to be aware of. In this week's podcast, I'm going to be focusing on operating profit, specifically, something called the operating profit margin.

I'm going to be looking at how we make the calculation, what it actually means, what influences the amount of operating profit margin we generate, how do we know if our margins are good or bad or indifferent, and some of the factors that will influence the size of the margin that we generate. Let's crack on.

Now, firstly, I want to outline two types of numbers that you're likely to meet in the financial world - and by types, in terms of how they're presented, how they're expressed. One number is expressed as what's called a relative number, typically a percentage, a fraction, a decimal, and in this context, I'm going to be referring to a margin as a percentage. The other type of number that how it's presented by the way is called an absolute value, and that's actually measured in the financial amount of pounds, dollars, or whatever currency you're trading in. Now, your operating margin, brackets operating margin percentage, is a measure of your business's profitability.

It tells you fundamentally how much profit your business is generating from its core operations. And this is after you take off what is referred to as cost of goods sold, quite a mouthful there, and your operating expenses. You may, folks, by the way, come across different terms for those two items I've referred to.

Cost of goods sometimes is called cost of sales. Some people use the expression direct costs. And operating expenses can be referred to as overheads, running expenses, and I can't really tell you why so many different terms exist, but if there's one term that exists in the finance world, us finance people will find a way to add a different variation.

Now, your operating profit margin is not the same as your gross profit margin because it won't be including things such as interest on your loans and borrowings, interest that you might receive from the investancy undertaking, or the taxes that you're liable for. The gross profit margin also, by the way folks doesn't include running costs or operating expenses, is purely comparing your cost of sales figure against your revenue. Now the operating profit is your gross profit deducted from that all the expenses, all the running expenses that you have in your business. And just add to this, by the way, if you hear the word operating profit, alternative terms that I've come across in my 30+ years of experience are net profits, some people use the term EBIT as a shorthand and acronym, which stands for earnings before interest and tax, UK equivalent is PBIT, which stands for profits before interest and tax.

Whichever way you carve it up, operating profit is before the consideration of interest and also tax charges. Now why do we need to know what the operating margin is? Well, because it's a good indicator, gives you good insight to how efficient your business is being run. It also indicates how well your management team, who are considered largely to be responsible for those operating costs and cost of sales, how efficiently they're operating as well.

A high margin means that you're generating an amount of profit in excess of what you might be expecting. A high margin means you're generating a lot of profit from your operations and your business is running smoothly. A low margin could mean you're not selling enough or your operation expenses are too high.

Now, a word of caution here, folks, when we do look at our figures, a figure by itself in isolation is absolutely useless. You need to have a benchmark. You need to have a context. You need to have a yardstick to which to compare it. Operating margins, for example, in the aviation industry, would not be the same as operating margins for a restaurant or the hospitality sector, or perhaps a service-based business like a firm of accountants. Cough, cough.

Also, if you're looking at your operating margin, make sure you've got a context and you're comparing it to either where you expect it to be, your plan, your budget, what you generated in previous periods, but make sure that number is compared to something that's meaningful. The next thing I want to look at is how do we actually calculate the operating profit margin.

Well, step one is we calculate the actual operating profit in pounds, or again substitute for your own currency. Now to do this, we need to know what our business's revenue is, we need to know what the equivalent cost of sales are and we also need to know the operating expenses. These numbers should be extractable quite easily from your accounting system, and if you're not able to extract those numbers quite easily, then I would suggest you need to visit and see what your infrastructure is like and go digital and make sure your accounting system is fit for purpose.

Please check out the link in the show notes, by the way, if you want to have further information on this or find out more. Now, operating expenses will include things like utility bills, insurance costs, staff salaries and wages, rent, and rates. Now, once you have this information to hand, you can calculate your operating profits by deducting from your total revenue, your cost of sales and operating expenses.

Remember, do not deduct the interest costs or the tax charges. They are not included in operating profit. Let's throw a few numbers into the mix. Assume your business has got a total revenue of 100,000 pounds last year. Your cost of sales or cost of goods sold was 50,000, and the operating expenses were 30,000.

That gives you a total operating profit of 20,000, and by way of a footnote, your gross profit would be 50,000. Now the next stage is to calculate the margin, and the margin is one number that's expressed as a relative figure i.e. in this case, as a percentage. Take your operating profit, divide it by your total revenue, and depending on what sort of calculator you have, multiply by 100.

If you're doing it on a spreadsheet, then the spreadsheet can be formatted accordingly. So using these numbers, we have a 20,000 pounds operating profit, we have a 100,000 pounds revenue, so 20 divided by 100 times 100, it gives you that 20% figure. Okay, so we got some understanding how we calculate the number.

We've got some understanding what it's made up of. But how do we know if it's good, it's bad, or it's indifferent? Well, critically, what we need to do is to compare that figure to something, something that's meaningful to us, something that's appropriate, something that's relevant for our business. So comparing, for example, a hospitality business to an aviation or transportation company is meaningless.

Comparing you as perhaps a small restaurant to a large restaurant chain, again, there is some comparability there, but it's not necessarily a like for like comparison because of sizes and everything else. If you compare it internally, look at your previous performance, look against your budget or your plan, and if you don't have one in place, then you need to really seriously think about having such a thing.

And check out the show notes at the end, by the way, for a link to our online planning platform, Budgetwhizz. Now, by nature, operating margins will be lower than the gross profit margin, because, remember, we haven't included overheads when we've calculated the gross profit margin. Now, if we see a movement upwards on the operating margin, let's say, for argument's sake, last year in our example, we had 15 percent profit margin.

This year we've got 20%, that's an improvement upwards. Now, there are a number of variables that can affect that. It could be we're selling more, and because our costs are relatively static, as far as our operating costs are concerned, then we'd expect to see a bigger percentage. It could be we're being more cost-efficient, being more productive,

and that will filter through. It could be our gross profits are improving, and therefore that will feed through into the operating profit margin. If however there's a decline and there's a movement downwards, again there could be a number of factors influencing that decline. It could be a conscious choice, we've just undertaken some investments, built up our infrastructure, investing more money in the business and therefore the operating costs, for example, things like additional depreciation, staffing salaries and the like are going to go up.

And we're not quite there yet, and the business isn't matured. We haven't realised all the revenues that we expected. Therefore, we'd expect to see a decline. Also, it could be we're being less efficient. We could be seeing a decline in our business. But what it should tell us, it gives us an indicator to investigate even further.

The reasons for the movement will be fundamentally due to something going on with the cost of sales, something going on with the revenue, or something going on with the operating expenses, or a combination of all three of those factors. In next week's podcast, by the way, folks, I'm going to be looking at something called economies of scale, and that will link back to our conversation today.

I said earlier, how do we know if what we've got is good or bad? Well, one insight will be gained by comparing that figure to how we performed previously, how we expected to perform, what our plans were, and benchmarking against that. Be very careful in terms of comparing yourself to other companies in your sector, make sure you're comparing like with like.

Make sure you're careful when you compare yourself to a different industry. Different industries will operate with different operating profit margins. So, for example, in the transportation sector, aviation, shipping, and the like, you'll find the operating margins will be relatively small. So in aviation, operating margins are going to be quite small in terms of single-digit figures, perhaps, but they've got huge volumes of turnover, and therefore a small percentage applied to a big value would give them a large amount of pound note profit.

Conversely, you may find in certain sectors, like service-based organisations, consulting, training companies, because the overhead base is quite modest, they will be generating higher profit margins. So what feels right for you may not be necessarily correct for somebody else. So what are the final thoughts, the conclusions?

Well, first of all, for me, it's important that you've got a good infrastructure and a data capture system to be able to extract the information to do these calculations. Please do check out the Budgetwhizz platform, by the way, and that online planning and calculation of metrics is part of that, and you can use that to compare with what you're actually capturing within your Xero account.

Operating profit margins will give us good insights to how we're performing. Profit is still an easily extractable figure, and it's a concept that most people will have an appreciation of, if not fully understand. And those metrics, matched up with other metrics that we have, give us a good insight and indicator how we're performing.

It will point us through to where the stress points are, where the successes are in our business. Folks, I hope you found this useful. I'd love it if you could share that episode with those who you feel would benefit. Let me know what your thoughts are. And do you actually know what your operating profit margins are?

Until next time, happy calculating. We hope you enjoyed this episode and appreciate you taking the time to listen to the show. We hope you got some value. If you did, then we'd love it if you shared the episode. We look forward to you joining us next week for another I Hate Numbers episode.