Operating income

Definition

Operating income is sometimes known as “operating profit”. It is the profit your company generates from its core business operations.   

What is an operating income?

Operating income is calculated by subtracting operating expenses and the cost of goods sold (COGS) from the company’s revenue. 

Operating expenses include salaries, rent, utilities, marketing, and depreciation of operating assets. 

Calculation of operating income

Here’s an example to illustrate:

Imagine a small bakery called “Sweet Treats”:

1. Revenue: Sweet Treats sells cakes and pastries for a total of £100,000 during the year.

2. Cost of Goods Sold (COGS): The cost of ingredients and direct labor to make the cakes and pastries is £30,000.

3. Gross Profit: Revenue – COGS = £100,000−£30,000=£70,000

4. Operating Expenses: 

• Rent for the shop: £10,000 
• Salaries for non-production staff: £15,000 
• Utilities: £5,000
• Marketing: £8,000 
• Depreciation on baking equipment: £2,000 

Total Operating Expenses = £10,000+£15,000+£5,000+£8,000+£2,000=£40,000

5. Operating Income: Gross Profit – Operating Expenses = £70,000−£40,000=£30,000

Now, let’s consider some non-operating items:

6. Non-Operating Expenses/Income: 

• Interest expense on a loan: £3,000 
• Gain from selling an old delivery van: £1,000

7. Income Before Taxes: Operating Income – Interest Expense + Gain on Sale of Van = £30,000−£3,000+£1,000=£28,000

8. Income Taxes: Let’s say Sweet Treats has to pay £7,000 in income taxes.

9. Net Income: Income Before Taxes – Income Taxes = £28,000−£7,000=£21,000

In summary:

• Operating Income (£30,000) tells you how much profit Sweet Treats made from its core baking and selling activities.   
• Net Income (£21,000) tells you the total profit Sweet Treats has left after considering all its expenses, including interest and taxes, as well as any non-operating income.
• The key difference between operating income and net income lies in the expenses that are deducted from a company’s revenue.   

Operating income essentially shows how profitable a company is from its main activities before considering the impact of non-operating items like interest and taxes.   

Operating income is sometimes referred to as Earnings Before Interest and Taxes (EBIT).   

Operating income vs Net income

As the owner of the business, you should know both operating and net income figures as they are crucial for analyzing a company’s financial health. 

Operating income shows the efficiency of the core business, while net income provides the overall profitability. A significant difference between the two can indicate the impact of non-operating factors on the company’s bottom line.