The net operating margin formula is used to determine how much money a company earns in comparison to its sales totals. This is an important measurement to make because it shows how efficient a company is at turning its sales into profits and whether or not it will be able to deal with the fixed costs not considered in the equation. Performing the net operating margin formula requires dividing a company's operating revenue, which is the amount it earns from goods sold after marginal costs are considered, by its gross revenue. As with most financial ratios, this one is best utilized when comparing a company to either its industry competitors or its own past performance.
It is common to think of the companies that amass the most sales as being the most successful in the business world. Yet no matter how much sales are accrued, they mean nothing if the company doesn't actually return some sort of profit. To do this, they must consider how to keep operating costs down and sales high. The net operating margin formula can show which companies are efficiently turning their sales into operational income.
When considering the net operating margin formula, it is important to understand exactly what is meant by operational income. Operational income is the money that remains after marginal costs like labor and raw materials for products are deducted. In essence, this is the money that the company actually takes away from their efforts to sell products.
Once this figure is determined, the net operating margin formula can be done. As an example, imagine that a company has amassed $500,000 US Dollars (USD) in sales in a year. In that same time period, the operating income earned amounted to $100,000 USD. The net operating margin for the company in that year's time would be $100,000 USD divided by $500,000 USD, which comes to .20, or 20 percent. That means that for every dollar sold, the company pockets roughly 20 cents while the other 80 cents goes to production costs.
Using the net operating margin formula to determine efficiency can be effective in certain instances. When comparing companies within the same industry, it can be helpful to see how they stack up in terms of their ability to turn sales into useful profits. Another way to use this formula is to compare a company against how it has done in the past. By comparing the net operating margins of various time periods, a company can see how its efficiency levels are trending over time.