What is Operating Income?

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Definition:

Operating income is a measure of the money that a business makes from its primary operations, minus the expenses it incurs to make that money, such as wages and cost of goods sold.

🤔 Understanding operating income

Every business has a primary business activity. Coca-Cola makes and sells beverages. Wal-Mart operates large retail stores and sells products to customers. McDonald's runs fast food restaurants. Operating income is the money that each business makes from running those operations, minus the cost of maintaining those operations, such as paying for raw materials and wages for employees. Operating income does not include other sources of revenue, such as gains from investments or exchanges from one currency to another. Operating income typically recurs from period to period, while non-operating income is more often caused by one-off transactions.

Example

A restaurant purchases meat, vegetables, and other products that it will use in its meals. It also hires chefs and waitstaff to work at the restaurant. Over one month, the restaurant brings in $100,000 in sales but spends $40,000 on food, $30,000 on wages, and $5,000 in depreciation costs for its equipment. The restaurant’s operating income for the month is equal to $100,000 – $40,000 – $30,000 –$5,000, or $25,000.

Takeaway

Operating income is like the money you expect to make from your job…

When you go to work every day, you usually expect to make money from showing up. Your employer agrees to pay you a set wage each day, and you agree to work. You pay some costs, such as transportation to get to work and food to eat during lunch. You can think of your daily pay, minus the costs of getting to work and eating, as your operating income. If one day on the way to work, you find a winning lottery ticket on the ground, you would not consider the money you get from that lottery ticket as part of your personal operating income because it isn't income from your normal work activities.

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What is operating income?

Operating income is the net income that a business produces from its primary business operations. For example, a restaurant would count money it makes from making and serving meals as part of its operating income. If the restaurant moved to a new location and sold its old building at a profit, the proceeds from the sale are not included in operating income.

Operating income subtracts out the cost of running the company's primary operations. For example, a restaurant subtracts the money spent on food and employee wages from net sales when calculating its operating income. Non-operating expenses, such as a loss incurred due to a lawsuit, are not subtracted from sales when calculating operating income.

Analysts look for operating income on a company’s income statement because it shows the revenue that a business generates from its activities. This income usually tends to be more stable from year to year than income from one-off events like the sale of an investment or a favorable exchange from one currency to another. A firm could turn a profit in one year because of one-off events, but still have inadequate operating income, potentially showing the weakness of its core businesses.

It's also often useful to compare operating income to a company's net sales to find how much of each transaction it retains as profit. If a company's net sales are $1 billion, but its operating income is just $10 million, it only keeps 1% of each transaction for other uses, spending 99% on making those sales. Businesses that retain more from each sale usually need to make fewer sales to keep operating.

What is included in operating income?

Operating income starts with the revenue that a business produces from its primary operations. A retailer includes its net sales to consumers but doesn't include things like investment income or other one-off income events. A dog walking service counts the money it receives for each hour of dog walking.

After finding the revenue produced by business operations, you must subtract the costs of producing that revenue. This includes both the cost of goods sold and other operating expenses.

Businesses usually need to purchase products or raw materials. A retailer might buy a shirt from the producer for $10 and sell it for $20. From the $20 in revenue, the business subtracts the $10 cost of the product sold. It also subtracts other related costs like the wages of the employee who sold the shirt. A manufacturing company deducts the value of the raw materials and direct production costs, including labor and allocated overhead.

Finally, operating income subtracts other operating expenses, such as rent, utility costs, commissions paid to salespeople, and insurance costs.

How do you calculate operating income?

To calculator operating income, find all of a business’s revenues related to its primary activities, then subtract the costs of those operations.

The formula for calculating operating income is:

Gross Income – Non-operating income – cost of goods sold – operating costs = Operating income

What is the difference between operating income and operating profit?

People frequently use the terms operating income, operating profit, and operating revenue. The meaning of each can vary slightly with the person you speak to in casual discussions.

Operating revenue is the income that a company produces from its business activities, without subtracting any of the costs. It is like net sales and may be preferred by service and other non-retail companies.

Operating profit is the total operating revenue that a firm earns, minus the operating costs that went into producing that revenue. Because operating income is a profit calculation, some people prefer the term operating profit.

Some people use operating income to refer to operating revenue, but this is not a generally accepted definition.

What is the difference between operating income and non-operating income?

Operating income refers to the money that a business earned from its primary operations rather than other, one-off sources of revenue.

For example, a retailer's principal operations include running stores and selling goods to customers. A sports team's activities include merchandising, selling tickets to games, and concession sales.

Operating income also subtracts the operating costs, such as wages, rents, and other expenses that directly affect the firm's ability to run.

Non-operating income looks at the money that a company makes outside of its typical business activities, as well as non-typical expenses.

To return to the sports team example just above, if the team sells its stadium to a developer, it won’t count the sale as operating income because it’s a one-off source of revenue and is not related to its typical business operations.

What is the difference between operating income and net income?

Operating income looks at the revenue and costs related to a company's core business activities. Net income looks at all the money that a business makes minus all the money that a business spends.

Net income measures the profit or loss that a business experienced during a period — including operating and non-operating income and expenses. This can be useful if someone wants to see the changes in a business's financial standing but isn't always considered the best measure if someone wants to assess the business's stability and ability to continue earning a profit.

Operating income is often considered a more useful measure of a business's stability and future prospects because it only looks at the revenue and costs generated by the business's core activities. A failing business may produce positive net income by selling off all of its assets, even though it produces no, or even negative, operating income for that time period.

What is the difference between operating income and revenue?

Revenue looks at all of the money that a business brings in, regardless of the source. It also does not subtract any costs. Revenue is useful because a company needs money to keep running. With no revenue, the business cannot finance its activities without drawing on debt or savings.

Operating income includes a portion of revenue. Specifically, it consists of the revenues that come from core operations and subtracts out operating costs associated with producing that portion of the business's revenue.

What is the difference between operating income and EBIT?

EBIT (Earnings Before Interest and Taxes), looks at a business's income after subtracting out certain expenses. Specifically, EBIT subtracts things like operating costs and cost of goods sold but ignores interest and tax expenses.

By looking at a company's net earnings without accounting for interest or taxes, analysts can sometimes get an idea of the company's ability to produce profit without regard for its financing strategy or local political effects on the business.

Operating income looks at the earnings that a firm produces from its core activities, minus the direct costs of producing those earnings. It also doesn't include indirect costs like interest or taxes. That means that a business with no non-operating income should have equal operating income and EBIT. If a business has non-operating income, EBIT calculations include that income, making it differ from operating income.

What is the difference between operating income and EBITDA?

EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) primarily looks at the money that a company earns after accounting for certain types of expenses. While it subtracts operating expenses and cost of goods sold, it doesn’t account for interest, taxes, depreciation, or amortization costs.

EBITDA doesn’t always appear on financial statements, but it sometimes lets analysts compare different companies without regard for the way they finance their activities or governmental influence in the form of taxes.

Generally, companies with high, positive EBITDA have steady cash flows and high potential profits — assuming they can pay off existing debts and reduce their tax burden. Negative EBITDA may indicate cash flow issues.

Operating income does include costs like depreciation and shows how much profit the business currently generates from its operating activities.

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