An operating margin is a financial metric that research analysts frequently rely on to measure the money a company generates from sales, after subtracting the costs of production, such as wages and raw materials, but before paying interest or taxes. This differs from the contribution margin, which specifically measures the production costs for an individual product. While analysts study operating margins in an effort to gauge a company’s overall profitability, contribution margins are internally used to help companies source areas where they may strive to increase their profit margins on a granular basis.
Understanding Operating Margins vs. Contribution Margins
Operating margins show the profit margin that remains after deducting operating costs, including employee salaries, facilities costs, and monthly rent, as well as marketing and advertising costs. Contrarily, the contribution margin analyzes profitability on a product-by-product basis, specifically by examining the variable costs associated with each product, such as packaging materials expenses. If a certain product is significantly less profitable than a company’s other products, that company can attempt to carve out ways of reducing production costs for that item, or it may elect to raise its price point to boost the profit margin.