Operating Profit Margin: A Key Indicator for Assessing Corporate Profitability

We will explore 'operating profit margin', which can be considered the heart of a company.'Operating Profit Margin' .

What is Operating Profit Margin?

Operating profit margin is one of the key indicators for evaluating a company's profitability, representing the ratio of operating profit to revenue. In other words, it is the value obtained by dividing the net profit, which is the profit remaining after deducting all expenses incurred in operating activities from the revenue generated by selling goods or services, by the revenue.

This is a very useful indicator for measuring a company's business performance, and it is often used by investors and financial institutions when evaluating a company's financial status. A higher operating profit margin indicates better profitability, suggesting strong competitiveness and growth potential.

Generally, operating profit margins vary by industry. While manufacturing and distribution industries may record high operating profit margins exceeding 10%, service and finance industries often exhibit relatively lower margins. Moreover, they can fluctuate due to economic cycles, competition, and other factors. They can also be improved through restructuring or cost reduction efforts.

How to Calculate Operating Profit Margin

Operating profit margin can be calculated using the following formula:

• Operating Profit Margin = (Operating Profit / Revenue) x 100

Here, operating profit refers to the amount obtained by subtracting the cost of goods sold and selling, general, and administrative expenses from revenue.

For instance, if a company's revenue is 100 billion won and its operating profit is 20 billion won, its operating profit margin is 20%.

Furthermore, if the revenue remains the same but the operating profit increases to 30 billion won, the operating profit margin rises to 30%. Since operating profit margin represents the final profit obtained as a result of a company's activities, it holds significant meaning.

Importance and Usefulness of Operating Profit Margin

Operating profit margin is one of the major indicators for evaluating a company's profitability. Investors use it to assess a company's financial health and business performance. Banks also use it as a reference when reviewing loan applications.

• The higher it is, the stronger the company's competitiveness. In other words, it possesses superior technological capabilities or brand value, enabling it to charge higher prices from customers or produce products at lower costs.
• It's useful for assessing stability. Even if revenue fluctuates due to economic changes, if the operating profit margin remains at a certain level, it suggests that the company has a stable revenue structure.
• It can be utilized for future projections. It is sometimes used to predict future conditions or set targets by analyzing past trends in operating profit margins. It can also be used to determine the relative position of a company compared to the industry average.

The Weight of Operating Profit Margin in Corporate Profitability Analysis

In financial statements, indicators representing a company's profitability include operating profit, gross profit, profit before income tax, and net income. However, operating profit margin is considered the most important indicator among them for the following reasons:

• It reflects pure operating performance. Gross profit is the value obtained by subtracting the cost of raw materials from revenue, and it does not consider selling, general, and administrative expenses. Therefore, it fails to accurately reflect the actual results of operating activities. On the other hand, operating profit deducts selling, general, and administrative expenses, such as labor costs, advertising costs, and rent, from gross profit, which reveals a company's true operating performance.
• It's an indicator that can gauge a company's sustainability. Operating profit reflects how well a company is performing in its core business. It is the profit before interest and taxes, making it crucial in evaluating a company's financial soundness and viability.
• It can be said to be the most important indicator from a shareholder's perspective. Net income is the value obtained by subtracting non-operating income and expenses and corporate tax from operating profit, representing the distributable profit for shareholders. However, it is influenced by factors unrelated to the core business, so operating profit margin is more suitable for determining a company's long-term profitability and growth potential.

Comparative Analysis of Operating Profit Margins by Industry

Operating profit margins vary significantly across industries. According to the '2021 Corporate Business Analysis' data released by the Bank of Korea, the average operating profit margin of 741,408 domestic non-financial for-profit corporations last year was 6.6%.

The manufacturing industry saw a 0.5% point increase to 9.0% year-on-year. This was driven by improvements in the operating profit margins of major industries such as electronics, video, and communication equipment (13.2%) and petroleum refining (22.8%), fueled by robust semiconductor exports.

On the other hand, the service industry saw a 0.7% point decline to 4.8% compared to the previous year. This was mainly due to the poor performance of accommodation, food, and beverage services (-26.9%) and arts, sports, and leisure (-10.2%), which were directly impacted by the COVID-19 pandemic.

The construction industry also experienced a decrease in operating profit margin from 5.2% to 4.4%, impacted by rising raw material prices.

As such, operating profit margins can differ depending on the specific sub-industry, even within the same industry. Therefore, when evaluating a company's profitability, it's essential to consider the characteristics of each industry.

Conclusion

Today, we explored operating profit margin, a key indicator for evaluating a company's profitability.