Question

1. What is the difference between operating margin and net income and why is it important to manage both?

Answer 1

Operating margin is Gross profit-Operating expenses

and Net income is Operating profit-Interest-Taxes.

The two measures are thus margins at different stages,

the first stage being operating profit and the second one

net income.

Operating margin excludes the financing charges

and the tax aspect. It stresses the net margin that the

firm makes after covering all operating costs and hence

measures the operating efficiency. Hence, its importance.

Once a firm covers its operating costs, then comes the

financing costs. The operating profit has to be sufficient

enough to meet the financing costs to leave something

to pay taxes and then leave something for the common

stockholders. The extent of borrowings determines the

financing costs and there should be sufficient operating

profits to support the financing costs and then leave

reasonable amount to the stockholders. If the operating

profits are not forthcoming the borrowing has to be

reduced.

Hence, both the operating margin and net income are

important.