Operating vs gross margin
Operating margin is EBIT over sales. On $100,000,000 of EBIT and $500,000,000 of sales it is 20 percent. Gross margin is gross profit over sales on a different firm: $700,000 over $2,000,000 is 35 percent. Do not paste that pile onto this top line.
| Operating margin | Gross margin | |
|---|---|---|
| Formula | EBIT / sales. | Revenue minus cost of goods, over revenue. |
| Teaching sheet | $100,000,000 of EBIT on $500,000,000 of sales is 20 percent. | $700,000 of gross profit on $2,000,000 of wholesale sales is 35 percent. |
| Where it stops | After operating costs, including D&A. The coupon has not come out. | After cost of goods. Wages, rent and D&A sit below. |
| A second sheet | Hold EBIT at $100,000,000, raise sales to $1,000,000,000: operating margin falls to 10 percent. | A software-shaped cost of goods prints 85 percent on the same $2,000,000 of sales. |
| What it is not | Gross margin. The 20 percent has paid more than cost of goods. | Operating margin. Pasting $700,000 onto $500,000,000 of sales mixes two firms. |
On this page
EBIT over sales is not gross profit over sales
Operating margin asks what share of sales survived as operating profit, before interest and tax:
On $100,000,000 of EBIT against $500,000,000 of sales that is 20 percent. Add $20,000,000 of D&A and EBITDA is $120,000,000, a 24 percent EBITDA margin on the cousin page.
Gross margin stops at cost of goods. On the wholesale sheet, $2,000,000 of sales minus $1,300,000 of cost of goods leaves $700,000, a 35 percent margin. That is a different firm. Do not paste those gross-profit dollars onto this $500,000,000 of sales.
How operating margin works owns the 20 percent. How gross margin works owns the 35 percent. Operating margin against net margin is the residual after the coupon.
Two firms, two reasons a rate can move
Keep EBIT at $100,000,000 and raise sales to $1,000,000,000. Operating margin is 10 percent. Profit did not fall. The top line doubled.
Hold wholesale sales at $2,000,000 and cut cost of goods to $300,000, the software-shaped sheet. Gross profit is $1,700,000. Margin is 85 percent. Liquidity on that sheet did not have to move. The cost base above the line did.
A 20 percent operating margin and a 35 percent gross margin are not a gap on one income statement. They are two teaching sheets. Gross margin against net margin is another pair that already warns against mashing firms. This is educational material, not financial advice.
Worked examples
20 percent on the operating sheet
EBIT is $100,000,000, D&A is $20,000,000, and sales are $500,000,000. What is operating margin?
- Operating margin: , which is 20 percent.
- EBITDA is EBIT plus D&A: , so $120,000,000.
- EBITDA margin is 24 percent. This page owns the 20 percent operating line.
Operating margin is 20 percent. EBITDA is $120,000,000. EBITDA margin is 24 percent. EBIT is $100,000,000. Sales are $500,000,000. D&A is $20,000,000.
35 percent on the wholesale sheet
A distributor sold $2,000,000 of goods that cost $1,300,000 to buy. What is gross margin?
- Gross profit is revenue minus the cost of goods sold: $2,000,000 minus $1,300,000 is $700,000.
- Gross margin is gross profit over revenue: , which is 35 percent.
- This is a different firm from the $500,000,000 operating sheet.
Gross profit is $700,000, a 35 percent margin on $2,000,000 of sales.
10 percent on \$1,000,000,000 of sales
Keep EBIT at $100,000,000 and D&A at $20,000,000. Sales are now $1,000,000,000. What is operating margin?
- Operating margin: , which is 10 percent.
- EBITDA is still $120,000,000.
- EBITDA margin is 12 percent.
Operating margin is 10 percent. EBITDA is $120,000,000. EBITDA margin is 12 percent. EBIT is $100,000,000. Sales are $1,000,000,000.
85 percent on the software-shaped sheet
A software company bills $2,000,000 a year, and its cost of goods sold is $300,000. What is gross margin?
- Gross profit is $2,000,000 minus $300,000, which is $1,700,000.
- Gross margin is , which is 85 percent.
- Same sales as the wholesale sheet, a different cost base, still not the $500,000,000 operating firm.
Gross profit is $1,700,000, an 85 percent margin on $2,000,000 of sales.
Common questions
Are these the same company?
No. The 20 percent is the EBIT sheet: $100,000,000 on $500,000,000 of sales. The 35 percent is the wholesale sheet: $700,000 on $2,000,000 of sales. This page puts the formulas side by side so the lines are not mashed.
Why is operating margin below gross margin on a real statement?
Because operating costs sit below cost of goods. This page does not print both rates on one firm. The 20 percent and the 35 percent are two teaching sheets.
Is 20 percent or 35 percent a target?
They are teaching-sheet readings. The third sheet prints 10 percent because sales doubled against the same EBIT. That is a different mix, not a failed year.
Keep reading
This page is educational material, not financial advice. The figures come from the formula shown and assume the inputs you enter hold for the whole term. Your own rate, fees, taxes and timing will differ, so treat the output as arithmetic to check a decision against, not as a recommendation.