What is Profit Margin?

Profit margin is the percentage of sales that a business retains after all expenses have been deducted. The calculation of the profit margin is sales minus total expenses, which is then divided by sales. The expenses included in this calculation includes both operating and non-operating expenses (such as interest expense and discontinued operations).

What is Operating Margin?

The operating margin reveals the percentage of profit generated by operating activities. The operating margin is calculated by subtracting all operating expenses from sales, and then dividing the result by sales. This margin is used to discern the profitability of an organization’s core activities, with all financing issues and discontinued operations excluded.

Comparing Profit Margin and Operating Margin

The key difference between the two margins is the non-operating activities that are not included in the measurement of the operating margin; these activities typically include financing transactions, such as interest income and interest expense. They may also include the returns generated by discontinued operations.

When evaluating a business, the operating margin reveals whether the core operations are capable of generating a return, which is especially evident when tracked on a trend line. This information can also be compared to the operating margins of competitors, to see how well a business is performing within an industry without the effects of financing considerations. This information is especially useful for acquirers, who are more interested in the operations of target companies than their finances.

The profit margin is of more use when evaluating an entity in its entirety, which includes both its operating results and financing activities. This result should also be tracked on a trend line, to evaluate performance over the long term. The profit margin tends to fluctuate more than the operating margin, since the profit margin also includes financing effects that can vary substantially as interest rates change.