Operating profit: the core business's true ability

STEP 1Operating profit is what the core business leaves

It is the third step of the income statement staircase. First make sure you know exactly what is subtracted to get this number.

When a bakery owner finishes a year of business and asks, "How much did I keep this year?", the first number that comes to mind is operating profit. Subtract the cost of making the bread (cost of goods sold) from the money earned selling it (revenue) and you get gross profit. In Lesson 13, Robin Bakery's gross profit was KRW 4.8 billion, a gross margin of 40%. But making bread is not the only cost. Store staff salaries, store rent, advertising and head-office running costs are separate. The costs of selling goods and running the company are called selling, general and administrative expenses, or SG&A for short.

What is left after subtracting SG&A from gross profit is operating profit. Things unrelated to the core business, such as interest, exchange rates, or money from selling land, are not included yet. That is why operating profit is often called "the true strength of the core business." Korean income statements show operating profit on its own line, which also makes it easy to compare companies.

Where did the KRW 3.3 billion of SG&A go?

The KRW 7.2 billion of cost of goods sold also contains KRW 1.7 billion of factory labor and KRW 800 million of oven depreciation (Lesson 13). Keep in mind that even for the same kind of labor, the pay of the person baking the bread goes to cost of goods sold, while the pay of the person selling it goes to SG&A. Companies draw this line a little differently, so comparing gross margin alone can mislead. Operating margin is the number after both costs are subtracted, so it is less affected by such differences.

You cannot tell on its own whether an operating margin of 12.5% is high or low. You need something to compare it to. Dark Cloud Electronics (fictional) has had revenue of KRW 24 billion and operating profit of KRW 800 million for 3 years, an operating margin of about 3.3%. Its revenue is twice Robin Bakery's, but the money it keeps from the core business is only a bit more than half. As we'll see in Part 4, this company is not even receiving that thin profit as cash.

STEP 2Operating leverage created by fixed costs

Now it's time to answer today's question. Let's split costs again into those that move with revenue and those that stay the same.

So far we have split costs into cost of goods sold and SG&A. This time, let's split them by a different criterion. Some costs rise every time you sell one more loaf, and some costs go out even if you sell no bread at all. The former are variable costs and the latter are fixed costs. Raw materials such as flour and butter are variable costs, because the more bread you bake, the more you use. Store rent, staff salaries and depreciation on the ovens do not shrink when less bread sells, so they are fixed costs.

To keep the math easy in this lesson, we'll assume that only Robin Bakery's KRW 4.3 billion of raw materials is a variable cost, and the remaining KRW 6.2 billion (labor 3.0, rent 0.8, depreciation 1.0, advertising and other expenses 1.4) is all fixed. In reality some SG&A, such as delivery fees, also moves with revenue, but this is enough to see the principle.

What happens when revenue grows 10%?

Suppose revenue grows 10%, from KRW 12.0 billion to KRW 13.2 billion. Raw materials rise 10% along with revenue, from KRW 4.3 billion to about KRW 4.73 billion. Fixed costs of KRW 6.2 billion stay the same. Operating profit is 13.2 − 4.73 − 6.2 = about KRW 2.27 billion. Revenue grew 10%, but operating profit grew about 51%, from KRW 1.5 billion to KRW 2.27 billion. Of the KRW 1.2 billion of extra revenue, KRW 430 million went to raw materials and the remaining KRW 770 million was kept entirely as profit, because the fixed costs had already been paid.

The reverse happens in exactly the same way. If revenue falls 10% to KRW 10.8 billion, operating profit becomes 10.8 − 3.87 − 6.2 = about KRW 730 million, a drop of about 51%. This phenomenon, in which fixed costs magnify a change in revenue several times over in operating profit, is called operating leverage. Like a lever, a small force produces a large movement.

Both companies have the same operating profit of KRW 1.5 billion this year. But if revenue grows 20%, Robin Bakery's operating profit more than doubles, while the light-structure company's grows by only about half. If revenue falls 20%, Robin Bakery slips into an operating loss, while the light-structure company still makes a profit. A company that owns its factory and equipment does well in booms and poorly in downturns. That is why profits in equipment-heavy industries such as semiconductors, shipbuilding and airlines swing so widely with the economy. The cyclical industries from Learn (Economics) Lesson 5 have exactly this kind of structure.

STEP 3Comparing with industry averages

Operating margins start from a different baseline in each industry. Use real statistics to measure whether a company is strong "for its industry."

The Bank of Korea "Financial Statement Analysis for 2025 (Preliminary)," which we used in Lesson 10 for debt-to-equity ratios by industry, also includes operating margin on sales by industry. These are 2025 averages for companies that undergo external audits. Try tapping the bars.

The 2025 all-industry average was 6.2%, up from 5.4% in 2024. The driver was electronics, video and communication equipment, which jumped from −3.7% in 2023 to 15.0% in 2025. These numbers show how much the semiconductor price cycle from Learn (Economics) Lessons 3 and 31 can shake the operating profit of an industry with large fixed costs. In 2023, falling chip prices put the whole industry in the red, and when prices recovered, margins rose several-fold. Shipbuilding and other transport also improved for 3 straight years: 2.8% → 7.2% → 11.7%.

By contrast, construction fell from 3.0% to 2.0%, and autos from 6.3% to 4.6%. Food barely moved, staying at 4.4–4.5% for all 3 years, because people do not cut back much on eating even when the economy is bad. Robin Bakery's 12.5% is a high level, nearly three times the food average (fictional). When you see a number like this, the right order is to first doubt it by asking “Is this really possible? Does the company have pricing power? Is it temporary?” and then read the business description (Chapter II).

Find it yourself on DART

In the annual report you opened in Lesson 3, go to III. Financial Matters → Consolidated Financial Statements and open the income statement (or statement of comprehensive income). 1 First check the unit above the table, 2 write down four lines, 'Revenue (sales),' 'Cost of goods sold,' 'Selling and administrative expenses,' and 'Operating profit,' in two columns, current and prior period. 3 Divide operating profit by revenue to get the operating margin for both years, and set revenue growth and operating profit growth side by side. The SG&A breakdown is in the 'Selling and administrative expenses' table in the notes. Item names can differ slightly from company to company.

How to use it in investing

The tendency for the profits of industries with high operating leverage to improve first and by more when the economy recovers also helps when reading the sector environment scores on the Macro Map. Look at them together with the economic phase on the Macro Map.

Not always. Industry averages can be pulled heavily by the results of a few large companies, and even within one industry each company has a different business structure. Operating margin is not a standard for picking a company; it is a signal about which part of the annual report to read in more detail.