Operating Profit Margin

One of the landmark metrics to assess the state of your business is operating profit. It essentially captures the profit you get from your business by considering both the revenues and the operating costs. It also indicates whether your business operates efficiently and whether there is still room for improvement. You will learn more about operating profit and its related quantity operating profit margin by reading this article.

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How is operating profit calculated?

Operating profit is calculated as follows:

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Operating Profit = gross profit - operating expenses

Gross profit is simply revenue minus the cost of goods sold:

Gross profit = revenue - cost of good sold

However, operating expenses include all other expenses you incur that are not part of the cost of goods but are essential to the operation of your business. The operating expenses include rent, equipment, inventory costs, marketing, payroll, insurance, step costs, and funds allocated for research and development. Taxes and debt payments are not included in the operating expenses, however.

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A related metric is called operating profit margin, calculated as follows:

Operating profit margin = (operating profit/revenue) x 100%

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Expressing the margin in terms of percentage of revenue easily gives you a way to compare how the operating profit margin changes over time compared to the revenue.

Why should you calculate operating profit?

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Operating profit is a straightforward metric to indicate the current health of your business. A positive operating profit means that your business is well-managed in terms of its operation: the revenue is greater than the expenses needed for its operation. A negative operating profit means you need to start looking at improving your operations or the pricing of your products.

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The operating profit is not the sole metric for indicating the current health of your business. This is because the operating profit does not include financial expenses in its calculations, such as taxes and debt payments. These expenses are relevant when finally determining the resulting cash flow of a business. Nonetheless, operating profit gives a clear picture of whether your business is running efficiently or not.

How can you improve your operating profit?

Supermarket Fruit Stand — *Image source*

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As several factors influence the resulting operating profit, there are several ways to improve it. Some of them will be discussed below.

Reduce cost of goods sold and trim waste from operations

The most obvious way to increase your profit margin is to reduce the cost of goods sold. The cost of goods sold (COGS) reflects the production costs of a product, from its raw materials to its processing and packaging. Some ways to reduce COGS are the following:

Negotiate for lower prices or secure bulk discounts for the raw materials
Reduce the costs of product packaging
Automate some of the steps of the production process

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You also inevitably get waste from your operations. Identifying its sources then reducing them is another way to increase your operating profit.

Improve inventory management

Not all of your products will sell equally; some will become bestseller hits while others sit for months in your warehouses before selling. If you are not able to identify popular and unpopular inventory, you will soon realize you cannot maximize your profits, as your bestsellers will sell out while the less popular products occupy much-needed space in your inventories. These problems can snowball into additional costs that are incurred due to products staying unsold for extended periods of time, besides the unrealized profits from the items remaining in your inventory.

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Improving the inventory management means getting an accurate birds-eye view of which items should be prioritized in the production. This reduces the overall costs and makes it possible to maximize profit with the given trends in your target market.

Increase the value of your brand

Another obvious way to increase operating profit is to increase your revenues. How can we do so? It is by increasing the value of your brand. You may be tempted to quickly increase the price of your products, but if you do so without increasing the value of your brand, there is a big chance your attempt will backfire.

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Increasing the value of your brand is in the realm of marketing, and it doesn’t have to be expensive. In fact, there are several ways to do so. Some of them might even surprise you! We regularly talk a lot about it. You can start by reading some of our articles on our blog.