Operating Margin Definition

Define Operating Margin in Simple Terms

Operating margin, also called the return on sales, is a measurement of how many dollars of profit a company earns per dollar of sales after paying operating expenses.

It considers costs such as wages, overhead, and materials, but does not include non-operating expenses like taxes or interest.

As such, it can also be seen as a measurement of how well a company is able to pay its non-operating expenses.

How to Calculate Operating Margin

Operating margin is calculated by dividing a company’s operating income by their net sales using the following equation:

Operating income is equal to a company’s gross income minus operating expenses, as follows:

Net sales is a company’s total sales revenue minus returns, allowances, and discounts.

Operating Margin Example

For example, say a company has an operating income of $500,000 and net sales of $1 million. Its operating margin is $500,000/$1 million, or 50%.

This means that the company makes $0.50 in profit for every dollar of sales revenue.

Like many financial metrics, operating margin is most useful when comparing two or more companies in the same industry.

Investors and analysts use operating margin to evaluate the risk of investment in a company.

Too low of a margin is an indicator that a company may have difficulty paying future expenses.

If the margin is especially low given the industry and business model, this could be due to poor management.

A margin that fluctuates drastically from year to year is also a risk sign to investors, as it indicates either an unstable income, changing operating expenses, or both.

Operating Margin Definition FAQs

Operating margin, also called the return on sales, is a measurement of how many dollars of profit a company earns per dollar of sales after paying operating expenses.
Operating Margin can be seen as a measurement of how well a company is able to pay its non-operating expenses.
Operating Margin is calculated by dividing a company's Operating Income into its Net Sales.
Operating Margin considers costs such as wages, overhead, and materials, but does not include non-operating expenses like taxes or interest.
Too low of a margin is an indicator that a company may have difficulty paying future expenses. If the margin is especially low, given the industry and business model, it could be a sign of poor management. A margin that fluctuates drastically from year to year is also a risk sign to investors, as it indicates either an unstable income, changing operating expenses, or both.
True Tamplin, BSc, CEPF®

About the Author
True Tamplin, BSc, CEPF®

True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.

True contributes to his own finance dictionary, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.

To learn more about True, visit his personal website, view his author profile on Amazon, his interview on CBS, or check out his speaker profile on the CFA Institute website.