Understanding business fundamentals are not as simple as it may first seem. If we only consider income there are different types that we must take into account when trying to get a clear picture of a company’s finances. In this article, we will be discussing operating income, also known as operating profit or earnings before interest and taxes (EBIT). We will also take a look at its formula, show some examples, and compare it to net income.
So if you are interested in learning more about this financial metric, keep reading.
Definition of Operating Income
Operating income is a financial figure that measures the amount of profit generated through a company’s operations after deducting operating costs such as wages, depreciation, and COGS (Costs Of Goods Sold). In simple words, it gives us an idea of how much money a company is making from its main business activities.
It is one of the major financial metrics that analysts use to assess a company’s performance and is often considered a more accurate measure of profitability than net income. Investors and analysts pay close attention to a company’s operating income because it is a good indicator of its future earnings potential.
Operating Income Formula
The operating income formula is calculated by subtracting a company’s total operating expenses from its gross income.
So the formula for Operating Income would look like this:
Operating Income = Gross income – Total Operating Expenses
- Gross income: Gross income is the amount of money a company earns from its primary business activities before any expenses are deducted. This is the amount of revenue that a company generates from its sales less the cost of goods sold (COGS).
- Total operating expenses: As the name suggests, these are all the expenses that a company incurs while running its business operations. This includes things like wages, depreciation, rent, etc. It is the sum of all the variable and fixed expenses incurred by a company during its normal course of business.
- Operating income: This is the final figure we get after subtracting total operating expenses from gross income. It tells us how much profit a company has made from its operations after all its operating costs have been taken into account.
Now that we know what operating income is and how to calculate it, here are a few examples to illustrate the concept.
Let’s say Company ABC has a gross income of $1,000 and total operating expenses of $500. So according to the formula mentioned above, we can calculate the operating income of Company ABC as follows:
Operating Income = $1,000 – $500
Operating Income = $500
This means that after deducting all its operating costs, Company ABC has an operating income of $500.
Now let’s say Company XYZ has a gross income of $10,000 and total operating expenses of $8,000. So the operating income of Company XYZ would be calculated as follows:
Operating Income = $10,000 – $8,000
Operating Income = $2,000
This means that even though Company XYZ has a higher gross income than Company ABC, its operating income is lower because it has higher operating expenses.
Comparison with Net Income
Now when it comes to net income, it differs from operating income in the sense that it includes all the expenses incurred by a company, not just the operating expenses. This means that things like interest payments, taxes, and other non-operating expenses are also taken into account when calculating net income.
Another key difference between the two is that while operating income only considers revenue from a company’s main business activities, net income also includes revenue from other sources such as investments, interest, and royalties.
However, both these financial figures are important in their own right and give us different insights into a company’s profitability. Both of them are crucial to understanding a company’s overall financial health and performance.
So there you have it. Operating income shows us how much profit a company has made from its core business activities after all its operating expenses have been taken into account. It is one of the major indicators of a company’s financial health and performance.