How operating margin works

Operating margin asks what share of sales survived as operating profit, before interest and tax:

$$\text{Operating margin} = \frac{\text{EBIT}}{\text{Sales}}$$

On $100,000,000 of EBIT against $500,000,000 of sales that is 20 percent. Add $20,000,000 of depreciation and amortisation and EBITDA is $120,000,000. EBITDA margin on that pile is 24 percent.

The operating margin calculator on this page prints both rates. This page owns the 20 percent operating line. How EBITDA margin works owns the 24 percent add-back line. Operating margin against EBITDA margin is the pair.

How gross margin works stops at cost of goods. How net profit margin works is the residual after interest and tax, on a different sheet. Do not paste that net-margin firm onto this $500,000,000 of sales.

Keep EBIT at $100,000,000 and D&A at $20,000,000. Raise sales to $1,000,000,000. Operating margin is 10 percent. EBITDA is still $120,000,000. EBITDA margin is 12 percent.

Profit did not fall. Sales doubled. A lower operating margin here is a fatter top line against the same EBIT, not a worse factory. The first sheet's 20 percent was the same $100,000,000 of EBIT on $500,000,000 of sales. Ranking those two sheets by operating margin ranks the top line, not a change in the operating profit pile.

How EBITDA margin works follows the add-back down to 12 percent on this sheet. The cousin rate moved for the same reason: the denominator doubled and the $120,000,000 did not.

Cut EBIT to $50,000,000 on the original $500,000,000 of sales. Operating margin is 10 percent, matching the second sheet. EBITDA is $70,000,000. EBITDA margin is 14 percent, which does not match the second sheet's 12 percent.

Two sheets can print the same operating margin for different reasons: more sales, or less EBIT. The EBITDA line tells those sheets apart. That is why the cousin page exists.

Operating margin against net margin is this line against the residual after the coupon.

It is not gross margin. Gross margin stops at cost of goods. Operating margin has paid the rest of the operating cost base: wages, rent, D&A.

It is not net margin. Interest and tax still sit below EBIT. A heavier coupon lowers net margin and leaves this rate still.

It is not a cash rate. EBIT has not paid tax, capex or working capital. How free cash flow works is the bridge that does.

EBIT and sales have to come from the same stretch of time. A year of sales against a quarter of EBIT is not a margin. Market cap in the denominator is a yield, not this ratio. How earnings yield works is that other fraction, on a different teaching sheet.

D&A is already inside EBIT. Adding it back is how you reach EBITDA. It is not a second operating profit. Type the EBIT and the sales your sheet is using. Trailing and next year's figures are not interchangeable.

It is not net margin, not a cash figure, and not a target of 20 percent. The three sheets are 20 percent on $100,000,000 of EBIT over $500,000,000 of sales (EBITDA $120,000,000), 10 percent when sales are $1,000,000,000, and 10 percent on $50,000,000 of EBIT (EBITDA $70,000,000). This is educational material, not financial advice.