Operating Profit Ratio: Definition & Interpretation

 

What is Operating Profit Ratio?

The operating profit margin ratio is also known as 'Operating Margin' ratio that measures how much percentage profit a company generates on a rupee of sales after paying for cost of goods sold, operating expenses, interest and taxes. 

Operating profit is a accounting term. Operating profit ratio is also called operating profit to sales ratio. 

Operating margin also measures managerial efficiency of the company.

Operating Profit Ratio Formula

It is calculated by dividing the operating profit by total revenue. It is also known as EBIT (Earnings Before Interest & Taxes) margin.

           Operating Profit Ratio=(Operating Profit/Total Revenue)×100

Where, 

operating profit= Total Revenue - (COGS + Office and administrative expenses + selling and distribution expenses)

Or, operating profit= (Net profit + Non operating expenses - Non operating income)
 
Operating expenses includes salaries, wages, rent, vehicle rent etc and non operating income includes dividend income, interest etc.

Operating Profit Ratio Example


Let, it is ABC company. Here is some information about ABC company.
 

Income statement for the year ended on                               31.03. 2019

Operating profit ratio= (900000/2000000)×100 = 45%

So, ABC company makes Rs 0.45 before paying interest and taxes for every rupee of sales.

Operating Profit Ratio Interpretation

Operating profit ratio is the ratio to the core sales of the business. It is a profitability ratio that established relationship between operating profit and net sales of firm. This ratio helps to analyze company's operational activities.

A company with higher operating profit indicates better management efficiency i.e. operating profitability and managerial efficiency of a firm.

A low operating profit ratio indicates improper management of the company i.e. the sign of managerial incompetence and low profitability of the firm.

To get the more accurate scenario regarding profitability and managerial efficiency all the other profitability ratio is to be determined along with operating profit ratio. 

There is no ideal figure but some analysis considered 20% to 30% is reasonable and vary on the nature of the industry and always estimates last 5 year operating profit ratio.