Operating income is a financial measure that shows a company’s profit from its operations before accounting for non-operating expenses such as interest, taxes, and other income or losses. It is also known as earnings before interest and taxes (EBIT).   

Operating income is calculated by subtracting the cost of goods sold (COGS), selling and administrative expenses, and depreciation and amortization from the company’s total revenue. The formula for calculating operating income is as follows:  

Operating income = Total revenue – COGS – Selling and administrative expenses – Depreciation and amortization 

Cost of Goods Sold 

COGS is the direct cost associated with producing goods or services the company sells. Selling and administrative expenses include sales, marketing, and general administrative expenses. Depreciation and amortization are the costs of using tangible and intangible assets over their useful life.  

Operating income is an important metric because it clearly shows a company’s profitability from its core operations. A higher operating income generally indicates that a company is generating enough revenue to cover its operating expenses and is operating efficiently. A lower operating income could mean that the company is facing cost pressures, which could lead to lower profits in the future.  

How to Calculate Operating Income 

It measures the profit generated by a company’s core operations, excluding non-operating expenses and income. It would help to subtract operating expenses from operating revenue to calculate operating income. The formula for operating income is:  

Operating Income = Operating Revenue – Operating Expenses  

Here is an example of how to calculate operating income:  

Suppose XYZ Corp has the following financial information for the year 2022:  

– Operating revenue = $5,000,000  

– Cost of goods sold = $2,500,000  

– Selling, general, and administrative expenses = $1,000,000  

– Depreciation expense = $500,000  

– Other operating expenses = $200,000  

To calculate the operating income for XYZ Corporation, we use the formula above:  

Operating Income = Operating Revenue – Operating Expenses Operating Expenses = Cost of goods sold + Selling, general, and administrative expenses + Depreciation expense + Other operating expenses Operating Expenses = $2,500,000 + $1,000,000 + $500,000 + $200,000 Operating Expenses = $4,200,000 

Operating Income = Operating Revenue – Operating Expenses Operating Income = $5,000,000 – $4,200,000 Operating Income = $800,000  

Therefore, XYZ Corp’s operating income for the year 2022 is $800,000.  

Note: Operating income does not include non-operating expenses or income, such as interest expenses or investment income. To calculate a company’s net income, you need to subtract these non-operating expenses or add non-operating income to the operating income.  

Operating Income vs. Other financial terms

Operating income is a financial term that measures a company’s profitability by subtracting its operating expenses from its revenue. It is also known as earnings before interest and taxes (EBIT). Other financial terms often used with operating income include net income, gross income, and EBITDA (earnings before interest, taxes, depreciation, and amortization).  

Net income, also known as the bottom line, is a company’s profit after all its expenses, including taxes, interest, and depreciation, have been deducted from its revenue. It is a more comprehensive measure of a company’s profitability than operating income.  

Gross income, on the other hand, is a company’s revenue minus its cost of goods sold (COGS). It is a measure of a company’s profitability before taking into account its operating expenses.  

EBITDA measures a company’s profitability that adds back depreciation and amortization expenses to operating income. This gives a better understanding of a company’s cash flow since these expenses are non-cash.  

Operating Income vs. Revenue

Revenue is the total income a company generates from its sales or services. On the other hand, operating income is the profit a company makes after deducting its operating expenses from its revenue. Operating income is a more meaningful measure of a company’s profitability than revenue since it considers the costs of running the business.  

For example, a company may have high revenue and operating expenses, such as salaries, rent, and utility bills, which can eat into its profits. Conversely, a company may have lower revenue but lower operating expenses, resulting in a higher operating income.  

Operating Income vs. EBIT and EBITDA

EBIT and EBITDA are measures of a company’s profitability similar to operating income. EBIT stands for earnings before interest and taxes, while EBITDA stands for earnings before interest, taxes, depreciation, and amortization. The key difference between these measures and operating income is that they add back certain expenses that are not included in operating expenses.  

EBIT adds back interest and taxes to operating income, while EBITDA also adds back depreciation and amortization expenses. These expenses are non-cash items that can significantly impact a company’s profitability.  

For example, a company with a large debt may have high-interest expenses, which can reduce its operating income. However, adding back these expenses can give a better understanding of a company’s cash flow and overall profitability.  

Operating Income vs. Net Income

Net income is a company’s profit after deducting all its expenses, including taxes, interest, and depreciation, from its revenue. On the other hand, operating income only considers the expenses related to running the business, such as salaries, rent, and utility bills.  

Net income is a more comprehensive measure of a company’s profitability than operating income since it includes all expenses. However, operating income is still an important metric since it clearly shows a company’s core profitability without the impact of non-operating expenses like taxes and interest. It is also useful for comparing the profitability of companies within the same industry, as it shows how efficiently a company is running its operations.  

In a Nutshell… 

In summary, operating income is an essential financial metric that shows the profitability of a company’s core operations before accounting for non-operating expenses. It helps investors and analysts to understand the company’s operational efficiency and profitability.  

Read Also: How Imputed Income Impacts Your Finances: Detailed Guide

Wajiha Danish

Wajiha is a Brampton-based CPA, CGA, and Controller with 17+ years of experience in the financial services industry. She holds a Bachelor of Science Degree in Applied Accounting from Oxford Brookes University and is a Chartered Certified Accountant. Wajiha spearheads Monily as its Director and is a leader who excels in helping teams achieve excellence. She talks about business financial health, innovative accounting, and all things finances.