Financial Ratios Part 10 of 21: Operating Profit Margin
Determining the efficiency of the business.
Financial Ratios & indicators can assist in determining the health of a business. There is a minimum of 21 different ratios and indicators that can be looked at by many financial institutions. You cannot look at a single ratio and determine the overall health of a business or farming operation. Multiple ratios and indicators must be used along with other information to determine the total and overall health of a farming operation and business. This series of articles will look at 21 commonly used ratios and indicators.
Operating Profit Margin is a measure of Profitability and is determined based on information derived from a business’ or farm operations Income Statement. The term Profitability is the difference between the value of what is produced or service provided and the cost of producing that product or providing that service. The Operating Profit Margin specifically shows how efficient a business is. Much of this can be contributed to the level of expenses (high or low). Low profit margin can be caused by a single variable or multiple variables combined such as high expenses, low prices on the products produced, or simply inefficiencies in the production phase of the business.
The following equation will determine your Operating Profit Margin:
Operating Profit Margin = Return on Assets/Value of Farm Production
Return on Assets = Net Income – Value of Operator Unpaid Labor and Management (a dollar amount will have to be determined to for the value of the owners unpaid labor and management, what would it take if someone had to be hired to do this)
Value of Farm Production = Gross Cash Income + or – Inventory Change of crops, market livestock, breeding livestock & Other Income Items – Feeder Livestock Purchased – Purchased Feed
Operating Profit Margin is measured as a percentage. This is another one of those measures that should be easy to understand, the larger the number the more efficient a business is. If the operating profit margin is at a level of 25% or higher the business or farm would normally be considered to be in good shape and strong. Anything less than 15% - 20% could be considered weak and vulnerable to negative markets and higher input costs.
If you have any further question please feel free to contact your local Farm Management Educator or the author.
You can read the other articles in this series:
Part 1: The current ratio
Part 2: Working capital.
Part 3: Working capital to gross revenues
Part 4: Debt-to-asset ratio
Part 5: Equity-to-asset ratio
Part 6: Debt-to-equity ratio
Part 7: Net farm income
Part 8: Rate of return on assets
Part 9: Rate of return
Part 11: The EBITDA measurement of profitability
Part 12: Operating profit margin
Part 13: Capital debt repayment margin
Part 14: Replacement margin
Part 15: Term debt coverage
Part 16: Replacement margin coverage ratio
Part 17: Asset turnover rate
Part 18: Operating-expense ratio
Part 19: Depreciation-expense ratio
Part 20: Interest-expense ratio
Part 21: Net income ratio