How to calculate operating income? Your business should review many financial reports when tracking its financial health. Those reports will tell you how healthy your company is financial. Creditors and investors will also check those numbers if your company is looking for money. One of the numbers you should calculate is operating income.
What is Operating Income?
Operating income is the ability of your business to generate revenue from its operations. Its core business activities, it measures the amount of money that a company makes. Other income that is not directly related to the business is not included in this calculation.
On the other hand, a non-operating expense is a one-time or unusual cost. This can include interest, lawsuit expenses, depreciation, obsolete inventory costs, etc.
Operating income is often referred to as operating profit or recurring profit. Operating income is also similar to earnings before interest and taxes (EBIT), but EBIT includes any non-operating income the company generates as well.
How Do We Calculate it?
Operating income is found in the income statement. Cost of goods sold (COGS) is subtracted from revenue at the top of the statement to find gross profit. Operating expenses are listed next and are subtracted from the gross profit. In the end, operating income is what remains after operating expenses are subtracted.
We now know where it is, so let’s calculate it:
Operating Income = Gross Income – Operating Expenses
Gross income is the money your business has left over after subtracting the cost of producing the product, also known as the cost of goods sold. Revenue is subtracted from gross income to determine gross income.
Operating expenses include all of the costs related to running your core business activities. In this category are things like utilities, insurance, rent, employee wages, and insurance.
We now know the basics, let’s look at an example:
Amy runs a flower delivery business and wants to expand it. In order to receive a business loan, she must prove her operating income to creditors.
Amy reviews her finances and finds that her business made $200,000 last month.
The rest of her expenses were:
- $3,000 in utilities
- $90,000 in employee wages
- $7,000 in insurance
- $6,000 in vehicle payment
- $8,000 in property and upkeep
- $1,000 in office supplies
- $7,000 in vehicle damages
- $20,000 in COGS
Now that we have all the information, the first step in calculating operating income is to calculate gross income.
Revenue – COGS = Gross Income
$200,000 – $20,000 = $180,000
Then we just need to add up operating expenses. Her expenses 1-6 are operating expenses because they have to do with running her business. She did not include the $7,000 in damages from line 7 because it was an extraordinary loss.
This leaves Amy’s total operating expense at $113,500.
Now, we can calculate operating income.
Gross Income – Operating Expenses = Operating Income
$180,000 – $115,000 = $65,000
As a result, Amy can now show investors or creditors that her business earned $65,000 in operating income last year.
What Does Operating Income Tell You?
The operating income of a company shows how profitable its core business operations are. The higher the operating income, the more profitable the business is. A business owner may use the operating income figure to measure the success of their operations.
Many things can affect operating income, including labor costs, prices of materials, and pricing strategy. Operating income is directly related to a business’s day-to-day operations, so it can help business owners make strategic decisions about how to grow or where to make changes.
Why Is It Important?
The operating income calculation is important because it separates the operating and non-operating revenue and expense, giving an outsider a clear picture of how the company makes money.
Investors and creditors can use the number to evaluate the business’s efficiency and profitability without regard to interest expenses or tax rates— two variables that may be unique from one company to another. Your business is more likely to pay back its debts if it has a higher operating income.
Business owners shouldn’t just look at their total revenue or the “bottom line” of their income statement. An analysis of your operating income on a regular basis will shed more light on your business’s overall health.