Operating margin helps gauge a company’s profitability and efficiency, as it measures the amount of revenue it is retaining from its operations, after accounting for its direct costs. It is important for investors and financiers to understand operating margin as it provides insight into how well a company is managing its cost structure.

In practice, the operating margin gives a company’s management a snapshot of its operating performance, as the figure shows how profitable the company’s core activities – or its operations – are. If the operating margin is high, it means the business is generating good profits from its operations.

Calculating the operating margin is relatively straightforward. Start by calculating the Operating Income (EBIT), by subtracting any operating costs and expenses from total revenue. This figure will then be divided by total revenue to get the operating margin. In many cases, this figure is represented as a percentage.

For example, assume a business has total sales (revenues) of $100 million and total operating costs of $70 million. Operating income would be $30 million ($100 million minus $70 million), and the operating margin would be 30% ($30 million/$100 million).

Normally, a higher operating margin is considered to be better than a lower operating margin; however, a comparison of margins between companies or industries should be taken with caution. Companies in some industries tend to have higher operating margins than others due to the particular nature of their business. For example, the operating margins of companies in the technology sector are traditionally higher compared to the margins of companies in the retail sector.

Operating margin is an important measure of efficiency and profitability and provides investors and stakeholders with insight into a company’s performance. Companies with higher operating margins have more capacity to cover their fixed costs and to invest in their own development. By comparison, companies with low margins are at risk of not being able to finance their operations with cash flow and may need to seek additional external financing