Operating income is your company’s earnings before taxes and interest. Understanding your operating income is crucial for evaluating your business’s performance. It offers insights into your company’s core profitability and management success.
In this article, we discuss what operating income is, the importance of calculating your business’s operating income and how to calculate it with examples.
Types of Income
Here are the types of income for a company:
1. Operating Income
Operating income is earned from a company’s operational activities. For example, it comes from selling manufactured goods.
2. Non-Operating Income
Non-operational income is income received by a company that is unrelated to or outside of the company’s product sales activities.
For example, such as rental income and interest. Rental income is the income obtained after renting an object to a company. While interest comes from lending money to other parties.
What is Operating Income?
Operating income reflects the profit a company retains after subtracting operating costs from sales revenue. These include both direct and indirect expenses.
Operating income is wages, depreciation and cost of goods sold including rent, marketing, equipment, payroll, inventory and other items that may be needed to run your business.
Operating income does not include other income, non-operating expenses, or non-operating revenue. Operating income is different from net income and gross income. This is because it includes more expense items than gross income but fewer than net income.
What is the Difference Between Operating Income and Net Income?
While operating income and net income both provide revenue figures, the formula evaluates unique aspects of the business.
Operating income shows you how successful a business is in operating and producing.
Some businesses may have a large number of loans with high interest payments that negatively impact their profits.
However, the company’s operations may be very successful. Operating income helps you and your stakeholders see how effective the company’s core is without breaking down other revenues or expenses.
Net income, however, represents the total income after all business expenses are accounted for. This figure indicates whether the business is profitable after covering bills, expenses, and taxes.
Unlike operating income, this calculation does not provide an indication of a company’s operational performance but instead offers a simple evaluation of earnings.
What is Included in Operating Income
Operating income includes amounts directly related to the operational activities of the business. Generally, this includes day-to-day expenses related to running the business, and profits, which are earned from daily sales. Operating expenses include:
- Rent
- Requirements
- Insurance
- Equipment
- Payroll
- Travel expense
- Office supplies
Because every business is unique with different goals, the types of revenue and expenses that constitute operating income can depend on many factors, such as the industry and the products or services provided by the business.
Even in the same industry, one business owner may classify certain expenses as everyday expenses, while another may classify them differently.
What is the Function of Operating Income?
Operating income is important for small and large businesses for a variety of reasons. Each business will likely have its own business goals and profit margins that they want to meet with operating income.
Here are the most common reasons why operating income is important:
- It serves as an indirect measure of how efficient your business is or will be in the future. The higher your operating income in your business, the more profitable your company is.
- Analyzing your business’s operating income is helpful to investors and other shareholders in your company because it excludes items that might distort profits.
- It shows how well your management controls expenses, overheads and production costs while generating more revenue.
- This allows you to analyze operating profitability as a measure of performance.
- You can start to assess your position compared to competitors in your industry.
- Calculating your operating income periodically will help you identify trends in your business and possible economic fluctuations.
When companies experience a decrease in operating income, they have less money for owners, debt reduction, and business growth.
Lenders and shareholders watch operating income closely because dividends must be paid to shareholders using money generated by selling products or providing services.
Operating income can fluctuate with economic conditions, but it is important to calculate your operating income regularly to identify trends and patterns in historical values to determine the reasons behind increases or decreases in operating income.
Why is Calculating Operating Income Important?
As we have discussed above. Operating income measures a business’s progress.
The higher the value, the better your business is doing.
Ideally, a good operating margin is one that is positive and continues to increase as the business progresses.
Understanding the difference between operating income and net income is important.
Simply put, operating income represents the revenue and expenses that come in and out of the business’s operational activities alone.
This will give you an idea of your business growth.
While net income can show how a surprise expense will impact your business.
After knowing the importance of operating income for the value of your business, by calculating it you can also find information such as:
- Company operational efficiency: By calculating operational income, you can indirectly measure how efficient your business is. A higher operating income indicates a more profitable company.
- Analyze performance: You help shareholders or investors calculate the profits they will get. And can also bring in new investors.
- Business management: Good operating income will reflect how good your management is in controlling expenses while running a business.
- Generating high profits: With a high profitability ratio value, it will show the company’s ability to generate profits at a certain level of sales, assets, and share capital.
How to Calculate Operating Income?
To calculate operating income, subtract the cost of goods sold from total revenue to get gross income, then subtract all operating expenses.
Operating income does not include taxes or interest income or expenses from investments and is needed to calculate operating margin, which will give you the operational efficiency of your company. The formula for calculating operating income is:
Basic formula:
- Operating income = Gross income – Operating expenses
- Deep formula:
- Operating income = Gross income – Operating expenses – Depreciation – Amortization
- Operating Income = Revenue – Cost of Goods Sold (COGS), Labor and other daily expenses
Case example in calculating operating income
Let’s simulate the calculation of ABC company’s operating income below.
You are the owner of ABC company. This year, your company’s gross income is $400,000,000.
This year, the company’s Cost of Goods Sold is $50,000,000, rental costs are $15,000,000, insurance is $12,000,000, and workers’ wages are $50,000,000.
Here’s how to calculate ABC company’s operating income:
Operational Cost = Rental Cost + Insurance + Worker Wages
Operational Expenses = 15,000,000 + 12,000,000 + 50,000,000
So Operating Expenses = 77,000,000
Operating Income = Gross Income – (Operating Expenses + COGS)
= 400,000,000 – (77,000,000 + 50,000,000)
= $273,000,000
Develop Your Business with Accurate Accounting Records with Billed
If you are interested in entering the business world, it is important for you to understand how to calculate your business income.
You can use accounting software like Billed and Agiled which can help you make more accurate calculations.
Financial reports have many features. These include reports on how to calculate profit and loss. You can use these features.
FAQs
What is the difference between operating profit and net profit?
Operating profit represents the financial balance resulting from a company’s main business operations, excluding non-operating financial items such as investment income and financial expenses.
It indicates whether revenues from business activities exceed the costs incurred to maintain them.
On the other hand, net income, also called net profit or net loss, is the final amount obtained after subtracting all expenses, including income tax, from operating income.
What is net operating income?
Net operating profit is the operating profit after deduction of corporate tax. It reflects the net profit produced by the company’s main business activities.
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