What Is Operating Margin? Meaning, Formula, and How to Improve It

Operating margin is the share of revenue a business keeps as operating income: what's left after the cost of what it sold and its operating expenses, such as rent, salaries and software, but before interest and income tax. You calculate it by dividing operating income by revenue. A 15% operating margin means the business kept 15 cents of operating income from each dollar of revenue.

Billed publishes this page. The definition below comes from the US Securities and Exchange Commission's Beginners' Guide to Financial Statements (last reviewed or updated February 6, 2017), and the income statement steps from the open textbook Principles of Accounting, Volume 1: Financial Accounting (OpenStax). Both were opened on October 29, 2026. This is general information, not accounting or tax advice; ask your accountant where judgment is needed.

The definition and formula

The SEC's guide says: "Operating margin compares a company's operating income to net revenues. Both of these numbers can be found on a company's income statement." It continues: "To calculate operating margin, you divide a company's income from operations (before interest and income tax expenses) by its net revenues."

Operating margin = operating income ÷ revenue

Multiply the result by 100 to show it as a percentage.

Where operating income comes from

OpenStax section 6.6 describes the multi-step income statement (section 6.6). It "deducts cost of goods sold from net sales to obtain a gross margin", and then: "Deducting the operating expenses from gross margin produces income from operations."

So operating income is:

1. Revenue minus cost of goods sold (or the direct cost of services), which gives gross profit;
2. minus operating expenses, such as rent, salaries that aren't part of the cost of what you sold, marketing, software and professional fees.

Interest and income tax come after operating income, so they don't affect operating margin. That's the difference from net income, which is after both. Operating income is also closely related to EBIT, and the step-by-step calculation is covered in how to calculate operating income.

Worked example: a small agency's year

The business and figures here are a sample, invented for this example.

• Revenue: $400,000.
• Direct cost of services (freelancers on client work): $160,000.
• Gross profit: $400,000 − $160,000 = $240,000, a gross margin of $240,000 ÷ $400,000 = 60%.
• Operating expenses: salaries $120,000 + rent $30,000 + software and tools $14,000 + marketing $16,000 = $180,000.
• Operating income: $240,000 − $180,000 = $60,000.
• Operating margin: $60,000 ÷ $400,000 = 0.15, or 15%.

The agency also paid $5,000 of interest on a loan. That comes after operating income, so the operating margin stays at 15% whatever the agency borrows.

What drives operating margin, and how to improve it

The formula shows the three levers: revenue, the direct cost of what you sell, and operating expenses.

• Price. If the agency raised revenue to $410,000 with the same costs, operating income would be $70,000 and the operating margin $70,000 ÷ $410,000 = 17.1%.
• Direct costs. Every dollar saved on the direct cost of services adds a dollar to operating income. Compare offers by their contribution margin before deciding which to keep.
• Operating expenses. If the agency cut operating expenses by $8,000, to $172,000, operating income would be $68,000 and the operating margin $68,000 ÷ $400,000 = 17%. For ways to do it, see how to reduce business overhead and how to automate business tasks.

A change in operating margin can come from any of the three, so check which one moved before you act. If gross margin held steady but operating margin fell, the change is in operating expenses.

Reading your operating margin

• Track your own trend. Compare the same period across months or years, using the same definitions each time.
• Compare like with like. Businesses with different models, such as products and services, have different cost structures. Ask your accountant which comparisons fit your business.
• Watch for one-time items. A one-off expense in one period, such as a move or a legal fee, lowers that period's operating margin without changing how the business runs.
• Check how owner pay is recorded. Whether the owner is paid a salary, which is an operating expense, or takes draws, which aren't, changes operating margin.

Where Billed fits

Billed's expense and receipt tracking page says to "Give every expense a category so your spending is already sorted when you file taxes or hand the year to your accountant," and that "Billed's expense report can group your expenses by category." Grouped this way, your expenses show which operating costs moved from one period to the next. Billed's financial reporting page lists "Income vs Expense Reports" among its built-in reports and says "Each report can be filtered by date range and exported." Ask your accountant how these reports line up with the operating income on your income statement.

When this guide isn't for you

This page covers operating margin for a small business. If you report under US GAAP or IFRS, present segment results, or need adjusted figures for investors or lenders, work with an accountant on the specific rules.

Related Articles

• How to Calculate Operating Income
• What Is EBIT (Earnings Before Interest and Taxes)?
• What Is Gross Profit?
• What Is Net Income?
• What Is Contribution Margin?
• What Is Overhead Cost?

Frequently Asked Questions

How do you calculate operating margin?

Divide operating income by revenue. Operating income is revenue minus the cost of goods sold and operating expenses, before interest and income tax. In the sample agency, $60,000 of operating income on $400,000 of revenue is an operating margin of 15%.

What is the difference between operating margin and net profit margin?

Operating margin uses operating income, before interest and income tax. Net profit margin uses net income, after interest, other revenue and expenses, and income tax. A business with a loan can have the same operating margin as one without, but a lower net profit margin.

What is the difference between operating margin and gross margin?

Gross margin is gross profit divided by revenue, so it only subtracts the cost of goods sold. Operating margin also subtracts operating expenses such as rent, salaries and software.

What is a good operating margin?

The sources cited on this page don't set a benchmark figure. Compare your operating margin with your own past periods, and ask your accountant whether there's a fair comparison for businesses like yours.

How can a small business improve its operating margin?

Raise prices where you can, lower the direct cost of what you sell, or cut operating expenses. In the sample agency, cutting operating expenses by $8,000 lifts the operating margin from 15% to 17%.