There are numerous calculations on a company’s income statement designed to highlight profits earned. One of these is operating income, which focuses solely on business operations. Keep reading to find out the answers to what is operating income, and how is it calculated.
Understanding operating income
Also known as income from operations, operating income is used in accounting to measure profit realized from the company’s operations. The profit is realized after deducting any operating expenses. It’s helpful to investors, because it provides a view of the company’s everyday profit without any one-off or unusual charges that could skew these figures.
Operating expenses can include any costs associated with running the business, like supplies and utilities. It also includes factors like cost of goods sold (COGS), depreciation, and payroll. To calculate operating income, you must deduct these operating expenses from gross income.
Operating income vs. net income
When glancing at the income statement, you’ll also see net income listed. Operating income is separate to this figure. While operating income shows all the of the business’s income from everyday operations, it includes more expenses line items than gross profit. Operating income factors in the COGS and all operating expenses.
However, net income accounts for all business expenses, not just those pertaining to everyday operations. It also includes other forms of income including non-operating income and non-operating expenses. Some examples of non-operating expenses could include things like interest payments, taxes, lawsuit settlements, or restructuring costs.
What is net operating income?
Operating income and net operating income are two terms that are often used interchangeably, but there are slight differences between the pair.
Net operating income is a term often used within the real estate industry, but it can also apply to any business or company that earns income from its property. To calculate net operating income, you must calculate all revenue received from the property, subtracting related operational expenses like utilities, repairs, and maintenance. Outside of the real estate sector, net operating income is often called earnings before interest and taxes, or EBIT.
Significance of operating income
Operating income is a useful measurement for business owners and investors alike, because it gives a clear picture of everyday revenue and its conversion to profit. This figure isn’t skewed by expensive lawsuit settlements or tax bills that might skew the profits of a single accounting period. Instead, if operating income increases from one period to the next it shows the company’s management is reliably generating revenue.
How to calculate operating income
There are a few different formulas to choose from when determining how to calculate operating income. To begin with, it’s helpful to define what qualifies as operating expenses. These include all expenses related to everyday operations, such as the following:
Marketing and sales materials
You can then use one of the operating income formulas below:
Operating Income = Total Revenue – Operating Expenses
In this case revenue refers to total sales minus returns from products sold. Find the total revenue on the income statement and subtract operating expenses. These expenses should include all direct and indirect costs associated with running the business.
Operating Income = Gross Profit – Operating Expenses
Another figure to use as part of your operating income formula is gross profit. Gross profit equals total revenue minus the COGS. It includes all of the company’s income, not just that generated from sales. Be sure to factor depreciation and amortization into your operating expenses.
You can find operating income on the income statement for each quarter. It’s usually calculated before net income, so appears as a line item above this figure.
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