Online Tutorial #3: How Do You Calculate A Company's "Operating Profit Margins"?
Changes in future operating profit margins can have a significant impact on shareholder value. This session focuses on where to find the data for and calculate historical operating profit margins and how to project future margins. As with previous sessions, we will use Gateway, Inc. as of April 21, 2000, as a case study. Readers who want to calculate operating profit margins while reading this tutorial may wish to download the accompanying spreadsheet.
What Does "Operating Profit Margin" Mean?
To understand what we mean by "operating profit margin," let's break this phrase down into its component sparts:
- Operating . This means we only include operational expenses in this calculation. Specifically, we exclude all costs associated with financing activities, including interest payments from debt and amortization of intangibles from acquisitions. We also exclude tax expenses from this metric, making this a "pre-tax" measure.
- Profit . This means we are calculating profits, i.e. what's left after subtracting expenses from
- Margin . This means we are calculating operating profit as a percentage of sales.
More specifically, "operating profit margin" equals the percentage of sales left after subtracting the following:
- Cost of sales
- General and administrative expenses
- Sales and marketing expenses
- Research and Development expenses
- Depreciation of property, plant and equipment.
- Any recurring non-financing expense associated with a company's ongoing operations
We do not subtract the following:
- Interest payments
- Amortization of goodwill
In accounting parlance, "operating profit margin" is equal to the "EBITA (Earnings Before Interest Taxes and Amortization) margin."
How Do We Calculate A Company's Historical Operating Profit Margin?
Returning to our Gateway case study, we can calculate operating profit margin using two methods:
1. Annual SEC 10-K filings. You can access Gateway's income statement from its fiscal 1999 filings by clicking here. Looking at this page, the information we need comes from this portion of the income statement: