Operating margins show a firm's ability to pay its fixed costs. Fixed costs are costs due each period, such as monthly. A common fixed cost is rent. Management can calculate operating margin by dividing operating income by net sales. Operating margin is important because it shows the ability of the firm to continue in the short run.
Determine the firm's operating income. Operating income is operating revenue minus operating expenses. Revenue and expenses from operations are any cash inflows or outflows that a firm has during its day-to-day operations. For example, Firm A has $500,000 of operating income for the month.
Determine the firm's net sales for the period. Net sales is the amount of sales during the period minus any deductions for allowances, returns and discounts. In our example, Firm A has $900,000 of net sales for the month.
Divide operating income by net sales to determine the firm's operating margin. In our example, $500,000 divided by $900,000 equals an operating margin of 0.555 or 55 percent.
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