Operating Margin Explained. Ratio That Tells Your Business Apart

Every business has its own core activities which are referred to as the Operating Activities.

Operating Income or Operating Profit refers to the profit that a business has after paying for all its Operating Expenses that include raw material costs, employee costs and all other operating bills. It is the amount available to cover the Interest & Tax obligations of the business. The Operating Profit when divided by the Revenue from Operating Activities gives us Operating Margin or Operating Profit Margin. It is a type of Profitability Ratio which implies how much a company earns as profit for every rupee of its sales.

The Operating Revenue (commonly referred to as Net Sales) is the total revenue generated from Sales less returns or discounts (if any).

Computation of Operating Margin:

Let us consider an example to understand the Operating Margin of a business.

Suppose, ABC Ltd has total yearly Sales of Rs 45,00,000/- out of which goods worth Rs 3,00,000/- are returned by the customers. Its operating expenses amount to Rs 32,00,000/- for the same period.

Operating Margin = Operating Profit / Net Sales

Hence, Operating Margin of ABC Ltd

= (45,00,000 – 3,00,000 – 32,00,000) / (45,00,000 – 3,00,000)

= 23.81%

An Operating Margin of 23.81% implies that ABC Ltd earns about 23 paise for every rupee of its Sales & has the same amount available to meet the Interest and tax obligations.

Business & Financial Relevance:

Operating Margin is a key indicator of the profitability of a business because it shows how much a company earns for every rupee of its Sales, hence implying the efficiency of its core business operations.

Banks & Financial Institutions look at the Operating Margins of a business to ascertain whether it will be able to cover its Interest obligations from the core business activities, hence businesses having low Operating Margins have a greater risk of default & Banks have an unfavourable perspective for lending to them. But we, at Loan Frame have developed a tech driven platform that not only considers your present business performance, but also takes into account the future improved performances due to the deployment of additional funds in the business’ core activities. We also understand that different sectors have different operating margin benchmarks and therefore provide you with the best business loan solution for your with the best possible terms.

Do you Understand Interest Coverage Ratio?

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