Operating margin, also referred to as EBIT margin, is a profitability ratio determining a company's ability to use its sales revenue to cover the direct and indirect operating expenses.
Operating Margin FormulaThe EBIT margin can be calculated using the formula: Operating Margin = Operating Income / Revenue x 100 Where: Operating income is the amount of sales revenue left after a company pays off its operating expenses.
Why Operating Margin Matters?EBIT margin is a useful metric because it looks at how much money a company generates from its core operations. Investors and creditors often use this metric to evaluate how profitable a company is expected to be. The higher the margin is, the more value a company creates for its shareholders and the less financial risk it bears. Thus, a high margin is generally a positive sign for investing in a company. Analyzing the trend of profit margin also tells if the company is constantly improving its profitability. This can be achieved through efficient cost control, increased customer demand, increased pricing, and other factors contributing to revenue build-ups. While operating margin is frequently used in financial analysis, it does not necessarily tells about a company's economic value or cash flow. Operating profit does not include capital expenditures and changes in working capital, which are items that could greatly impact cash flows. In other words, significant capital expenditures (i.e. purchase of PP&E) increases the amount of investing cash flows, and thus the total cash flow could be negative if Capex exceeds operating margin in that specific period.
More Useful ResourcesCheck out CFI's complete guide on EBIT margin to learn more about the definition, formula, and examples of using the metric. You can also browse all accounting templates on CFI Marketplace to find useful worksheets for your daily accounting and finance duties!
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