The operating margin measures how efficiently a company converts the revenue it generates into operating profit.
Operating Profit Margin = Operating Profit / Net Sales
Company ABC makes sales of Rs 100 Cr and the total operating expense is Rs 80 Cr. Then, the Operating profit is Rs 20 Cr (Rs 100 Cr – Rs 80 Cr) and Operating Profit Margin (OPM) is 20%.
For every Rs 1 of revenue, this company generates an operating profit of Rs 0.2
How to use practically
Operating Profit Margin is the single most important metric that Banks look at before giving any kind of loan to the company.
Having a high-profit margin is a good sign of the competitive strength of the company. Investors must look at the trend of the OPM before investing in the company.
The declining trend is a worrisome sign and the increasing OPM trend is a strong signal of the inherent strength of the business and tight cost control done by the management.
A business that is capable of generating operating profit is a positive sign for shareholders of the company and the lenders of the company.
This means that the company’s operating margin creates value for shareholders and lenders of the company.
In most businesses, most of the operating expenses go into buying raw materials and employee benefits (salary, pension, etc).
So it is necessary to know the trend of raw material price and hike/decline in the salary of employees to get a clearer picture of OPM.