Operating profit is simply defined as below:
Operating profit = Gross Profit – Operating Expense
Since the absolute numbers can seem pretty, they make more sense when seen in relation to total revenues. Value of a company can be judged by checking the proportion of Revenues left after paying for Cost of Goods Sold and Operating Expenses, expressed as Operating Margin (%):
Operating margin (%) = Operating profit/ Revenue
Operating margin provides the earnings power of a company. It gives an indication of the cushion that the company has after paying for its bills. Needless to say, higher this cushion, better are the chances that the company can survive tough times better than the companies with thinner operating margin.
If the operating margin is improving or has been consistent over the years, I would be more comfortable in investing in such a company.
Chapter 4 – Operating expenses (SG&A; R&D; Depreciation)