Operating Profit - Formula, Equation, Margin, Ratio & How to Calculate

What is Operating Profit?

Operating profit is the profit a company makes from its core business operations, before accounting for interest and taxes.

It is also called EBIT (Earnings Before Interest and Tax) or operating income.

It is the money a company earns from doing what it's actually supposed to do, manufacture products, provide services or run its main business. This is before loan interests or taxes cloud the picture.

The Operating Profit Formula

The basic formula is,

Operating profit = Revenue - cost of goods sold - operating expenses Or more simply, Operating profit = Gross profit - Operating expenses

Let's understand each component

• Revenue (sales) - Total money earned from selling products or services.
• Cost of goods sold (COGS) - Direct costs of producing goods. This includes raw materials, labour and manufacturing expenses.
• Operating expenses - Indirect costs like salaries, rent, marketing, utilities, depreciation.

Operating Profit Margin

Operating profit margin shows what percentage of revenue becomes operating profit. It's calculated as,

Operating Profit Margin = (Operating Profit / Revenue) × 100

What's a Good Operating Profit Margin?

This varies by industry, as every industry depends on different inputs. Also, it’s important to consider various other parameters before concluding good or bad.

Generally, by trend, we can categorise a few industries based on margin, like,

• High margin industries (20%+) - Software and IT services, pharmaceutical and financial services
• Medium margin industries (10-20%) -Consumer goods, automobile, retail
• Low margin industries (below 10%) – Airlines, grocery, retail and a few other commodity businesses

A 15% margin in airlines would be excellent, whilst the same margin in software might be considered poor. Always compare companies within the same industry.

Operating Profit Ratio

Operating profit ratio is the same as operating profit margin, expressed as a percentage.

Operating Profit Ratio = (Operating Profit / Net Sales) × 100

This ratio helps investors assess,

• Management efficiency in controlling costs
• The company's pricing power
• Operational effectiveness compared to competitors

If Company A has a 20% operating profit ratio and Company B has 10%, Company A is more efficient at converting sales into operating profit (assuming the same industry).

Operating Profit Compared to Other Profit Metrics

• Gross Profit - Revenue minus only direct costs (COGS). Doesn't account for operating expenses.

• Operating Profit -Revenue minus COGS and operating expenses. Shows core business profitability.

• Net Profit - Operating profit minus interest, taxes and other non-operating items. The final bottom line.

Example

• Revenue - ₹100 crores
• Gross Profit: ₹40 crores (after COGS)
• Operating Profit - ₹15 crores (after operating expenses)
• Net Profit - ₹10 crores (after interest and tax)

Each level tells you something different about the business.

Using Operating Profit for Investment Decisions

When analysing stocks for investment decisions, check

• Consistent operating profit - Does the company consistently make operating profit or is it erratic?
• Growing margins - Is the operating profit margin improving over the years? This suggests better efficiency.
• Comparison with competitors - How does this company's operating profit margin compare to its peers?
• Trend analysis – Is the company’s operating profit growing faster than its revenue?

That's a good sign.

Where to Find Operating Profit

You can find the operating profit numbers shared in annual reports, quarterly results, financial websites or stock exchange filings It's usually listed as ‘Operating Profit’, ‘EBIT’ or ‘Profit from Operations.