Operating Income

Operating income, also referred to as operating profit or Earnings Before Interest & Taxes (EBIT), is an accounting figure that measures the amount of profit realized from a business’s operations, after deducting operating expenses such as wages, depreciation, and cost of goods sold (COGS). It also can be computed using gross income less depreciation, amortization, and operating expenses circuitously because of the assembly of products. Expense, interest income, and other non-operational revenue sources aren’t considered in computing for operating income.

Operating income also called income from operations takes a company’s gross income, which is reminiscent of total revenue minus COGS, and subtracts all operating expenses. A business’s operating expenses are costs incurred from normal operating activities and include items like office supplies and utilities.

Operating income and operating profit are sometimes used as a synonym for EBIT when a firm does not have non-operating income and non-operating expenses. For example, income from the firm’s financial investments would be added to the operating income to determine EBIT. Analyzing operating income is helpful to investors since it doesn’t include taxes and other one-off items that might skew profit or net income. A company that’s generating an increasing amount of operating income is seen as favorable because it means that the company’s management is generating more revenue while controlling expenses, production costs, and overhead.

Operating income tells investors and company owners what quantity revenue will eventually become profit for a company. It’s important because it’s an indirect measure of efficiency. The upper the operating income, the more profitable a company’s core business is. Several things can affect operating income, including:

  • pricing strategy
  • prices for raw materials, or
  • labor costs

These items directly relate to the daily decisions that managers make. This means operating income also measures managerial competency.

There are three formulas to calculate income from operations:

Operating income = Total Revenue – Direct Costs – Indirect Costs

Or

Operating income = Gross Profit – Operating Expenses – Depreciation – Amortization

Or

Operating income = Net Earnings + Interest Expense + Taxes

To calculate operating income, we must find the total revenue (gross income), cost of goods sold (COGS), and the operating expenses on the income statement. Operating expenses include:

  • Labor and salaries
  • Day-to-day expenses like rent and utilities

Operating income does not account for the following:

  • interest expenses
  • non-recurring items such as accounting adjustments, legal judgments, or one-time transactions, and
  • other income statement items not directly related to a company’s core business operations

Sales revenue or net sales is the monetary amount obtained from selling goods and services to business customers, excluding merchandise returned and any allowances/discounts offered to customers. This will be realized either as cash sales or credit sales. Gross income, on the opposite hand, is that the monetary result obtained after deducting the price of products sold and sales returns/allowances from total sales revenue.

Operating income is required to calculate the operating margin, which describes a company’s operating efficiency. Many companies concentrate on operating income when measuring the operational success of the business. It is considered a critical indicator of how efficiently a business is operating. It is an indirect measure of productivity and a company’s ability to get more earnings, which might then be used to further expand the business. Investors closely monitor operating profit in order to assess the trend of a company’s efficiency over a period of time.

Operating profit, like profit and net income, maybe a key financial metric employed in determining the price of the company for a possible buyout. The upper the operating profit as time goes by, the more effectively a company’s core business is being carried out.

 

Information Sources:

  1. corporatefinanceinstitute.com
  2. investopedia.com
  3. investinganswers.com