Operating Income: What Is It?
Your business’s accounting is important to its success. As such, having an intimate knowledge of the terminology and formulas used is a must. This knowledge helps increase your business’s success, and can guide financial decisions. One of the most important terms to understand is operating income. If you’re getting more invested in your company’s accounting, understanding operating income should be at the top of your list. Learn all you need to know about it in this article.
Here’s What We’ll Cover:
What Is Operating Income?
Operating income is an accounting figure that measures profit. This operating profit is the amount of profit made from business operations. This amount of money is determined after subtracting operating expenses from profit. The figure is sometimes referred to as actual profit, as it is calculated after expenses. Some of the operating expenses subtracted are:
- Wages and salaries
- Administrative expenses
- Depreciation cost
- Cost of merchandise
- Supplier costs
- Business supplies (office supplies, etc.)
Operating expenses are incurred from any operations that are required for a business to run.
Operating Income is Similar to Earnings Before Income Taxes (EBIT)
Operating income measures how much of a business’s sales revenue will eventually become profit. This makes it similar to a company’s earnings before income taxes, or EBIT. EBIT is also called operating profit or recurring profit. The biggest difference between the two lies in the method of income measurement. Operating income only measures profit made from business operations. EBIT includes any non-operating income that a company makes. This includes income made from investments, rental income, and appreciation.
Why Is Operating Income Useful?
Because it doesn’t include all income, operating income may seem less useful than EBIT. However, this is not the case. Company analysis using operating income is helpful to business owners and investors. This is because it doesn’t include one-off items that could skew profit or additional income.
When looking at companies to invest in, investors want to see income from operations with a steady growth rate. This means that management is making decisions that increase profitability over time. They’re able to generate more revenue while controlling production and non-production costs. They’re also keeping extra expenses and overhead costs to a minimum.
Most accounting software options offer the ability to create operating income statements. This is a great way for you to keep an eye on your business’s operating income, and success.
Calculating Operating Income
To calculate operating income, there is an easy formula. The formula is displayed below:
Operating Income = Gross Income - Operating Expenses
In the equation, gross income can be defined as the total income from all operational sources. This can be found by subtracting all the cost of goods sold from the gross revenue. This excluded any income made from investments, taxes, and interest expenses.
Operating expenses include selling, general, and administrative expenses (SG&A). It also includes depreciation, amortization, and other operating expenses. Operating income is required to calculate the operating margin. The operating margin describes a company’s operating efficiency.
How to Find Operating Income Using an Income Statement
Looking at a company’s income statement will provide all of the necessary information to calculate operating income. When looking at Company A’s income statement, you see that they have a gross income of $10 million. They have an operating expense of $3.5 million. To calculate, we’ll plug these figures into the formula.
Operating Expense = $10 million - $3.5 million
Operating Expense = $6.5 million
It’s as easy as that! When you’re looking at financial statements, it’s important to note that gross income and gross margin are interchangeable.
Things to Take Into Consideration
When reviewing operating income, it’s important to remember a few important things. These are all listed below.
Operating Income and Net Income Are Different
While both of these figures show the income earned by a company, they express earnings differently. Operating income is revenue minus any operating expenses. Net income is operating income minus any other non-operating expenses. To find net income, you have to have the operating income first.
Operating Income is Not the Same as Profits
Operating income is whatever is left after subtracting operating costs. However, it doesn’t take into account any other expenses, like taxes. Profits are what is left over after subtracting all expenses from revenue.
Additionally, a high operating income doesn’t necessarily mean that a business is very profitable. In fact, there’s too much information missing from this figure to make that call. You have to take into consideration that a high operating income doesn’t consider non-operating costs. This means that any one-time payments or extra costs can significantly reduce profit.
On the other hand, operating income doesn’t consider any sporadic forms of income, either. As such, a business may be more profitable than its operating income lets on. To determine profitability, all of a business’s financial statements should be reviewed. A single financial statement doesn’t provide the full picture for any company.
Non-Operating Income Still Exists
Non-operating income is a larger factor in some cases than others. As such, it can have an effect on a business’s success. Some forms of non-operating income are dividend income, interest, and capital gains.
Companies Provide Their Operating Income Figures
While you can look at a company’s financial statements and determine it for yourself, they normally provide it. A company’s operating income can be found on the income statement. It is common to find it at the bottom of the statement, as its own line item. Companies provide this figure next to non-operating income. This helps investors to distinguish what money is made from normal operations, and what is not. It is significant because it tells them if investing should be considered.
Operating income is just one of many financial figures that demonstrates what a company makes. This figure tends to be a bit limited in scope, but when paired with others it can be very useful. A high operating income tends to mean a business is more successful, though that isn’t always true. If you’re looking to increase your financial knowledge further, visit our resource hub. We provide all of the information you need to help make your business more efficient. Check it out today!