Operating Income Ratio, also known as Operating Margin, is the percentage of Total Revenue that remains after subtracting Cost of Revenue and Operating Expenses (such as SG&A and R&D). It shows how much profit a company makes from its core business for every dollar of sales.
Why is Operating Income Ratio Important?
Operating Income Ratio is important because it:
Evaluates Operational Efficiency: Indicates how well a company controls its production and operating costs relative to revenue.
Facilitates Comparisons: Allows investors to compare profitability across companies and industries regardless of size or capital structure.
Informs Strategic Decisions: Helps management identify cost-saving opportunities and assess the impact of pricing and cost strategies.
How is Operating Income Ratio Calculated?
Operating Income Ratio is calculated using the formula:
Operating Income Ratio = (Operating Income ÷ Total Revenue) × 100
Where:
Operating Income = Total Revenue − Cost of Revenue − Operating Expenses
Total Revenue = Sales from goods or services
For example, if a company has $300 million in revenue, $180 million in direct costs, and $60 million in operating expenses, its operating income is $60 million, and its operating income ratio is (60 ÷ 300) × 100 = 20%.
Additional Considerations
Trend Analysis: Monitoring the ratio over time highlights improvements or declines in cost management and pricing power.
Benchmarking: Comparing to industry peers helps identify competitive strengths or areas for improvement.
Impact of One-Time Items: Understanding adjustments for non-recurring expenses ensures a clearer view of recurring operating performance.