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What is Operating Income?
What’s important to know about it?
In this article, I will break down the meaning of Operating Income so you know all there is to know about it!
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Let me explain to you what Operating Income is and why it’s important!
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What Is Operating Income
In accounting, operating income refers to the amount of money a company generates from its business operations after it has deducted its operating expenses, costs of goods sold, wages, and depreciation.
In other words, a company’s operating income is how much profit the company generates through its normal business operations.
To calculate the operating income, you must take a company’s gross income from operations, which is total revenues less costs of goods sold, and deduct the company’s operating expenses.
A company that generates an operating income that is higher than its costs of goods sold, wages, operating expenses, and depreciation is profitable from its operations.
Measuring a company’s profitability by focusing on its operating income is important as it allows investors and financial analysts to see if the company’s operations have the potential to generate profits.
Keep reading as I will further break down the meaning of operating income and tell you how it works.
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Why Is Operating Income Important
Operating income is an important profitability measure as it allows you to see how much a company is generating in income from its operations.
The higher a company’s operating income, the more the company has the potential to turn that income into net profits.
One reason evaluating a company’s operating income is important and useful is that it’s a measure that only considers the company’s operations.
Any one-time revenues or non-recurrent events are not captured in this measurement.
Companies that are consistently generating operating income in excess of their operating expenses and costs of goods sold are seen as more productive than others.
In addition, a company that is able to demonstrate a steadily increasing operating income is perceived to be doing better over time.
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How To Calculate Operating Income
To calculate the operating income, you can use the following formula:
Operating Income = Gross Income – Operating Expenses
As you can see from this formula, you need to find a company’s gross income and operating expenses to be able to calculate the operating income.
Gross income refers to a company’s total income minus the cost of goods sold.
Operating expenses refer to selling, general, and administrative expenses, depreciation, amortization, and any other operating expenses.
When you calculate a company’s operating income, you are excluding all one-time or non-recurring events from the calculation so you can get a better picture of the company’s operating profitability.
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Interpreting Operating Income
Isolating a company’s operating income allows investors, financial analysts, and company managers to determine how well the company is doing.
When a company’s operating income increases over time, it means that the company is generating more money from its operations.
As a result, the company can potentially generate higher profits.
When a company’s operating income is stable, company managers can assess whether this is a good sign or a bad sign.
A mature company may consider that a steady operating income is a good outcome whereas a growing company may consider that a stable operating income does not meet its desired target.
Finally, a low operating income or a negative one is a sign that the company may be in trouble.
If a company is not generating money from its operations or is losing money, unless the company takes immediate corrective measures, it can run into liquidity problems.
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Operating Income Example
Let’s look at an example of operating income to better understand the concept.
Let’s assume that Company ABC sells consumer products generating $10,000,000 in total sales.
It must spend $4,000,000 to produce the goods.
Then, the company incurs a total of $1,000,000 in selling, general, and administrative expenses, must pay $1,500,000 in wages, and has $500,000 in depreciation.
Now, we must start by calculating the company’s operating income.
Operating income is the company’s total income ($10M) minus the cost of goods sold ($4M), representing $6,000,000 in our example.
Then, we’ll need to calculate the company’s operating expenses.
The company’s operating expense is the SG&A expenses ($1M), wages ($1.5M), and depreciation ($0.5), giving us a total of $3,000,000.
The final step is to take the operating income ($6M) minus the operating expenses ($3M) giving us $3,000,000.
In this example, Company ABC is profitable converting 30% of its total revenue to operating income.
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What Is Operating Income FAQ
Is operating income the same as net income?
Operating income is not the same thing as net income.
Operating income is a measure of a company’s profitability based on the revenues it generates from its normal operations and its recurring expenses.
As a result, operating income excludes one-time events and non-operating income.
On the other hand, net income measures a company’s profits from all operating and non-operating channels.
This means that net income will include one-time or non-operating income.
Is operating income the same as EBIT?
Operating income is not the same thing as EBIT.
The main difference between the two is that operating income only considers operating revenues and expenses.
However, EBIT considers non-operating items other than interest and taxes.
EBIT will include anything labeled as “Other Income / Loss” on the income statement.
What is a good operating income?
A good operating income depends on the objectives set by the company managers.
For example, a mature company having an operating income representing 25% of its total income may find its performance acceptable.
However, investors in a rapidly growing company may consider that 25% operating income is very low for the company as it will not have enough money to pay for the debt it has on its balance sheet.
In essence, you’ll need to assess a company’s overall picture to see if the operating income should be a cause of concern or not.
How do you calculate operating income?
You can calculate operating income by taking a company’s net sales, less cost of goods sold, less operating expenses.
Net sales refers to the total revenues generated by the company from its operations.
The cost of goods sold refers to how much it costs the company to produce its goods.
Operating expenses refers to all expenses incurred by the company from its operations.
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So there you have it folks!
What does operating income mean?
In a nutshell, operating income refers to the amount of money a company has left over when it deducts all operating expenses from its total sales revenue.
A company’s operating income is a key indicator of how efficiently the company is operating.
Banks, investors, financial analysts, and company managers measure operating income to see how well the company is generating income from its operations.
The higher the operating revenues, the more a company is able to generate income from its core business operations.
In essence, you can consider operating income to be a company’s net income without considering the impact of financing activities and taxes.
Now that you know what operating income means and how it is calculated, good luck with your research!
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