Which one of the following is correct formula for calculating operating margin?
Click on the arrows to vote for the correct answer
A. B. C. D.C
The correct formula for calculating operating margin is option C, which is operating income divided by net sales.
Operating margin is a profitability ratio that measures the percentage of revenue that a company generates from its operations after deducting operating expenses. It is also known as operating profit margin or return on sales. Operating margin is an important metric that shows how efficiently a company is managing its expenses and generating profits from its core business activities.
Here is a breakdown of the formula components:
Operating income: This is the profit that a company earns from its primary business operations, before deducting interest and taxes. It is also known as EBIT (earnings before interest and taxes) or operating profit. Operating income is calculated by subtracting operating expenses from gross profit.
Net sales: This is the total revenue that a company earns from its sales, after deducting any discounts, returns, and allowances. Net sales is also known as net revenue or net sales revenue.
To calculate operating margin, you divide operating income by net sales and multiply the result by 100 to express it as a percentage:
Operating margin = (Operating income / Net sales) x 100
For example, if a company has operating income of $100,000 and net sales of $500,000, its operating margin would be:
Operating margin = (100,000 / 500,000) x 100 = 20%
This means that for every dollar of revenue generated by the company, it earns 20 cents of operating income.
Option A (Net profit/Net sales) is incorrect because net profit includes not only operating income but also other income and expenses such as interest income and expenses, taxes, and non-operating gains or losses. Therefore, it does not provide an accurate measure of a company's operating performance.
Option B (Net income/Net sales) is also incorrect for the same reason as option A. Net income includes all income and expenses, both operating and non-operating, and is therefore not a reliable measure of a company's operating profitability.
Option D (Operating income/credit sales) is incorrect because it uses credit sales instead of net sales. Credit sales are only a portion of net sales and do not take into account cash sales or any discounts or returns. Therefore, this formula would not accurately reflect a company's overall operating margin.