Tag Archives | operating profit

Operating Profit Margin Example

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Operating Profit Margin Ratio Analysis

Operating Profit Margin Example

In an operating profit margin example, Bill is the founder and CEO of a retail store called Shopco. Shopco recently took a loan. Shopco has experienced a dip in sales, because of the recession, and wants to make sure they can keep net operating profit margin ratio above the limit in their loan agreement. If not, Shopco may have their loan revoked. Shopco decides to prepare for this scenario by looking at their books and finding all relevant numbers. Bill then performs the calculation below.

Revenue $ 1,000,000 Cost of Goods Sold $ 500,000 Gross Margin $ 500,000 Operating Cost $ 250,000 Interest Expense $ 25,000 Operating Profit $ 225,000 Operating Profit Percentage 22.5%

Shopco was required by the bank to maintain an operating profit margin about 10%. After performing the calculation Bill now knows that his operating profit margin ratio calculation is above this. Bill feels very relieved. He also now has the confidence to survive through his time of difficulty.

Operating Profit Margin Meaning

The meaning of operating profit margin varies slightly, although the basics stay the same across all industries. This makes it a common and important metric. Operating profit margin ratio analysis measures a company’s operating efficiency and pricing efficiency with its successful cost controlling. The higher the ratio, the better a company is. A higher operating profit margin means that a company has lower fixed cost and a better gross margin or increasing sales faster than costs, which gives management more flexibility in determining prices. It also provides useful information for investors to determine the quality of a company when looking at the trend in operating margin over time and to compare with industry peers.

There are many ways for a company to artificially enhance this ratio by excluding certain expenses or improperly recording inventory. Revenues may also be falsified by recording unshipped products, recording sales into a different period than they actually occurred, or more. Usually, it serves more as a general measurement than a concrete value.

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Operating Profit Margin Example

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Operating Profit Margin Example

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Operating Profit Margin Ratio

See Also:
Operating Profit Margin Ratio Example
Net Profit Margin
Operating Income (EBIT)
Financial Ratios
Gross Profit Margin Ratio Analysis
Interest Expense

Operating Profit Margin Ratio

The operating profit margin ratio indicates how much profit a company makes after paying for variable costs of production such as wages, raw materials, etc. It is also expressed as a percentage of sales and then shows the efficiency of a company controlling the costs and expenses associated with business operations. Furthermore, it is the return achieved from standard operations and does not include unique or one time transactions. Terms used to describe operating profit margin ratios this include the following:

Operating Profit Margin Formula

In order to calculate the operating profit margin ratio formula, simply use the following formula:

Operating profit margin = Operating income ÷ Total revenue

Or = EBIT ÷ Total revenue

(NOTE: Want the Pricing for Profit Inspection Guide? It walks you through a step-by-step guide to maximizing your profits on each side. Get it here!)

Operating Profit Margin Calculation

The operating profit margin calculations are easily performed, including the following example.

Operating Income = gross profit – operating expenses

For example, a company has $1,000,000 in sales; $500,000 in cost of goods sold; and $225,000 in operating costs. In conclusion, operating profit margin = (1,000,000 – 500,000 – 225,000)= $275,000 / 1,000,000 = 27.5%

In conclusion, this company makes $0.275 before interest and taxes for every dollar of sales.

If you want to learn how to price profitably, then download the free Pricing for Profit Inspection Guide.

Operating Profit Margin Ratio

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Operating Profit Margin Ratio

Resources

For statistical information about industry financial ratios, please go to the following websites: www.bizstats.com and www.valueline.com.

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Fixed Charge Coverage Ratio Definition

Fixed Charge Coverage Ratio Definition

Fixed Charge coverage ratio, defined as a measure of how well a company can meet its fixed financial obligations (such as interest and leases) with its operating profit, also serves as a measure of the ability of a company to pay bills owed. It indicates the financial risk involved in paying fixed costs within a company’s business operation. This ratio acts as a risk indicator.

In a sense, the Fixed Charge Coverage Ratio allows a company, as well as outside companies, to know if a business can fulfill its financial obligations. Within the company, the fixed charge coverage ratio allows a company to fully understand the capabilities of the organization. More specifically, it allows the company to understand what projects can be undertaken and which projects must be scrapped for another time. More accurately put, the fixed charge coverage ratio is a strong indicator of how successful a company is going to be, both from inside the company and from the outside looking in.

Fixed Charge Coverage Ratio Explanation

Fixed charge coverage ratio, explained, is a strong indicator of a company’s future problems if sales drop to any extent. It is especially important for a company who spends heavily on leases. The lower the operation profit, the worse negative effects of fixed payments will become. For example, a company will feel heavier burden of lease payments combined with interest expense with declining sales. At the same time, this could deter possible outside investors to support a company with a negative fixed charge coverage ratio.

Though the ratio is just a numerical figure, the implications of this number have important effects on a company. Though, it is not completely impossible to improve a company’s fixed charge coverage ratio. As a company improves its ability to pay bills and debts, the ratio will improve. If a company’s ratio is not quite as good as they would like, it is beneficial to at least show a positive trend in where the ratio is headed.

If you want to increase the value of your organization, then click here to download the Know Your Economics Worksheet.

fixed charge coverage ratio definition

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fixed charge coverage ratio definition

See Also:
Fixed Charge Coverage Ratio Analysis
Financial Ratios
Key Performance Indicators (KPIs)

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Economic Value Added

See Also:
Activity Based Management
Capital Structure Management
How to collect accounts receivable
How to manage inventory
Why Exit Planning

Economic Value Added Definition

Economic value added (EVA) measures the effects of managerial actions. It also focuses on managerial effectiveness in a given year.

Economic Value Added Formula

Use the following formulas to calculate the EVA:

EVA = Operating profit after taxes – Cost of all capital

Or = (Sales revenue – operating costs –taxes) – (total capital supplied * cost of capital)

Economic Value Added Calculation

For example, a company has $10,000 in operating profit, $50,000 in debt and weighted average cost of capital of 10%. The economic value added calculation can be found below:

EVA = 10,000 – (50,000 * 10%) = 5,000

Applications

EVA is an estimate of a company’s true economic profit for the year. But it differs substantially from accounting profit. It depends on both operating efficiency and balance sheet management. Furthermore, without operating efficiency, operating profits will be low. In addition, without efficient balance sheet management, there will be too many assets, hence too much capital. In conclusion, it results in higher-than necessary capital costs.

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economic value added

economic value added

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