Definition
The term operating profit margin is used to describe a measure that allows analysts to understand the rate of return from the core business operations of a company. This metric removes the effects of non-operating income activities such as the sale of assets.
Calculation
Operating Profit Margin (%) = ((Sales - COGS - SG&A) / Sales) x 100
Where:
Sales include the total revenue in the current period.
The Cost of Goods Sold (COGS) includes raw materials, direct labor and production overheads.
Sales, General and Administrative Expense (SG&A) includes office supplies, back office labor such as accounting, sales salaries, payroll costs, advertising, as well as utilities (electricity, water, heating fuels).
Explanation
Operating performance measures allow the investor-analyst to understand how well a company is performing with respect to sales, margins, and profits. One of the ways to measure the effectiveness of a company’s core business is by calculating their operating profit margin.
This metric first determines the company’s operating income by taking revenues and subtracting out the SG&A and COGS. This value is then divided by revenues to derive the company’s operating profit margin. This measure allows the investor analyst to understand the profitability of a company’s core business operations, since it excludes extraordinary transactions as well as income derived from the sale of assets. The measure also excludes interest expense, thereby eliminating the effects of financing decisions.
Example
Company A’s new Chief Financial Officer would like to have a deeper understanding of the company’s ability to generate profits from its core business operations. She asked her analysts to provide her with several metrics, including the company’s operating profit margin. Using the company’s latest income statement, the analyst put the following table together.
| Sales Revenues | $12,500,000 |
| Cost of Goods Sold | $6,700,000 |
| Gross Margin | $5,800,000 |
| Selling, General & Administrative Expense | $986,000 |
| Operating Profit | $4,814,000 |
From the above information, the analyst was able to calculate Company A’s operating profit margin as:
= Operating Profit / Sales Revenues, or = ($4,814,000 / $12,500,000) x 100, or 38.5%
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