OP/S (Operating Profit to Sales): Definition and Uses

Definition

OP/S — the operating profit to sales — is the PLI that prices the tested party’s result against its revenue base: the operating profit (the numerator) over the sales / revenue (the denominator) — the operating margin. It is the PLI of record for the distributor and the manufacturer in TNMM — the tested party whose result prices the goods it sells, and whose economics are the margin on the revenue rather than the mark-up on the cost.

OP/S = operating profit ÷ the sales (the revenue base)

Numerator: the operating profit — the operating revenue less the operating
           costs and the cost of goods sold (the item definition stated in
           the file; the financial and the non-operating items treated)
Denominator: the sales — the operating revenue from the function (the goods'
           sales, on the tested party's revenue line; the related-party
           sales included, on the tested party's basis)

The use	The content
The tested party’s PLI	The distributor’s / manufacturer’s operating margin — tested against the pool’s OP/S distribution (the IQR, the mid-point)
The pool’s PLI	The comparables’ OP/S, on the same item definition — the numerator’s comparability (the operating profit as defined) is the pool’s comparability
The adjustment base	The working-capital adjustment on the revenue base (the days’ computation — the working capital adjustment); the TPO’s adjusted OP recomputes the numerator on its item treatment

The working distinction (the PLI reference): OP/S and OP/OC price the same operating result on different bases — the sales base for the tested party whose result prices the goods (the distributor, the manufacturer), the cost base for the tested party whose result is the mark-up on the effort (the service provider). The denominator’s discipline differs with it: the revenue base’s questions are the revenue’s completeness (the related-party sales, the other income treated) and the cost of goods sold’s definition; the cost base’s questions are the allocation and the excluded items. The gross margin method is the margin-on-revenue economics as the India-specific standalone method; TNMM on OP/S is the same economics benchmarked against the pool.

Example

The tested party (an Indian distributor) buys the group’s product and sells it in India: the operating revenue is ₹500 cr, the operating profit (revenue less the cost of goods sold and the operating costs, on the stated definition) is ₹12.5 cr. The tested party’s OP/S is 2.5%. The pool (the comparable distributors, the same definition) distributes at the IQR 2.1%–3.4%, mid-point 2.8%. The position: inside the IQR — documented. The working-capital adjustment (the current-asset / current-liability days, on the revenue base) is applied to the pool before the range; the TPO’s adjusted-OP question recomputes the numerator (the forex gain, the investment income — the items, against the file’s stated definition).

See also

• OP/OC (Operating Profit to Operating Costs)
• Operating Margin · TNMM (the guide)
• Distributor Transfer Pricing

FAQ

OP/S or OP/OC for the manufacturer? OP/S, where the manufacturer’s result prices the goods it sells (the sales base, the operating margin) — the tested party is the manufacturer, and the pool is the comparable manufacturers on the same definition. The PLI reference carries the mapping; the denominator’s discipline (the cost of goods sold’s definition, the revenue’s completeness) is the manufacturer’s comparability detail.

What is the denominator’s comparability question for OP/S? The revenue’s definition, stated and applied identically: the operating revenue from the function (the goods’ sales — the related-party sales included on the tested party’s basis, the other income treated, the discounts and the returns netted). The pool on a different revenue definition (the gross revenue, the net revenue, the revenue plus the other income) is a pool that is not comparable on the PLI — the definition is the comparability, as much as the members are.

How does the TPO’s adjusted-OP treatment work on OP/S? The denominator stays the file’s (the revenue base, as defined); the numerator is recomputed on the TPO’s item treatment — the non-operating income removed (the forex gain, the investment income), the non-operating expense added back (the interest, the exceptional items) — to the adjusted OP, and that is benchmarked against the pool. The fight is on the items’ character, item by item, against the file’s stated numerator definition.