Operating Income vs. Net Income: Which Should You Pay Attention To?
The difference between operating income and net income is that operating income does not take into consideration non-operating income such as the income from investments, expenses from financing, taxes and non-recurring expenses or income items, such as the gain on the sale of an asset.
Net income, on the other hand, is the bottom-line profit that factors in all expenses, debts, additional income streams, and operating costs.
What this article covers:
- What Is the Difference Between Net Income and Net Operating Income?
- How to Calculate Operating Margin?
- What Is the Formula for Calculating Operating Margin?
- What Is a Good Operating Margin?
What Is the Difference Between Net Income and Net Operating Income?
While operating income is the income you generate through your operations, net income is final bottom line income for the business.
What Is Operating Income?
Operating income is the profit of a business after deducting fixed operating expenses and variable expenses including the cost of running the day-to-day operations such as rent and payroll, depreciation and amortization and the cost of goods sold.
It is calculated by using the following formula:
Operating Income = Gross Income – (COGS + Operating Expenses + Depreciation and Amortization
What Is Net Income?
Net income refers to the profits of the business after accounting for all income and expenses.
This includes not just the operating income but also non-operating expenses. These are extraordinary or non-recurring expenses — things you wouldn’t regularly be spending money to run your business such as a large equipment purchase that only happens once every 4-5 years.
The formula for calculating net income is:
Net Income = Operating Income + Investment Income – Interest Expense + Extraordinary Income – Extraordinary Expenses – Taxes
How to Calculate Operating Margin?
Operating margin of a business is the profit that the business makes after paying variable costs of production but before paying tax or interest. It is a good indicator of the operational efficiency of the business.
What Is the Formula for Calculating Operating Margin?
The operating margin is calculated by dividing the operating income of the business by its sales revenue.
Operating Profit Margin = Operating Income / Sales Revenue
What Is a Good Operating Margin?
The operating margin depends on the sector of business. Since the capital structures, levels of competition and scale efficiencies are different from industry to industry, the operating margins can vary widely.
Ideally, a good operating margin is one that is positive and steadily increasing over time.
Understanding both operating and net income is important. While operating income represents the revenue and expenses flow in and out from business operations alone and can give you a clearer picture of the trajectory of your business growth, while net income can show you how surprise expenses are affecting your business.
If your operating income is healthy, your business value will likely be healthy regardless of your net income.