What Does It Mean When Operating Income as a Percent of Net Sales Increases Each Year?
Operating income expressed as a percentage of sales is referred to as operating profit margin or just operating margin. This is a common profit ratio derived from your company's income statement. Net sales is simply the total revenue generated in a given period minus the amount of returns and allowances. When your operating margin is increasing every year, it means your company is increasing sales and controlling costs.
Net sales typically shows up as top-line revenue on a monthly, quarterly or annual income statement. This is the net amount of revenue generated from regular product and service sales. You subtract cost of goods sold, or COGS, which include the costs of raw materials and resale goods acquisition. This leads to gross profit. You then subtract operating or fixed costs, including salaries, utilities and building costs, to produce the periodical operating income or profit.
You can actually compute three profit margins from the income statement -- gross margin, operating margin and net margin. You simply divide each particular income amount by the net sales, or revenue shown. If your operating profit for the period was $40,000 on revenue of $200,000, your operating margin equals 0.2, or 20 percent. This means you converted 20 percent of revenue into operating profit. To assess this performance, you must compare your margin to industry norms and your company's historical trends. When your margin rises, this is a good sign.
In simplest terms, the fact that your operating profit as a percentage of net sales increases over time means you are improving your ability to generate revenue and control costs. A number of factors contribute to optimized revenue. Effective marketing and promotion to develop desirable solutions and attract eager buyers helps you get top dollar on sales. By retaining established customers and adding new ones each period, you increase your product demand and ability to maintain stable prices and margins.
Your increased operating margin may have resulted from both higher revenue and lower costs, but you can sometimes improve the margin just with better cost control. With improved products and services, your product returns might have lowered, which improves net sales, and therefore revenue. You can reduce COGS through supplier negotiations, increased buying activity or improved distribution and logistics. You can also reduce fixed costs with better building contracts or improved energy efficiency.