What Is Operating Income and How to Calculate It

When attempting to calculate and highlight the profits earned by a company, one of the many metrics you can use is operating income. This metric focuses solely on business operations and makes it simple for companies to measure their profits and deduct operating expenses from gross income.

In this article, we’ll be taking a look at how operating income is calculated, why it’s used, and comparisons to other similar metrics.

Definition of Operating Income

So, what is operating income? 

Operating income is usually described as income gained from your business operations. It’s most commonly used as a metric in accounting to help calculate how much profit a company has gained from its business operations.

The profit gained is usually calculated against any expenses, making it a great metric to help business owners and accountants create reports and plans of action for future business growth.

However, operating income can also be a good way to help investors learn more about a company’s everyday profits without taking into consideration anything that could skew the figures.

Calculating Operating Income

In its simplest form, calculating operating income is done with the following formula:

Operating Income = Gross Income - Operating Expenses

However, you can also use:

Operating Income = Total Revenue - Operating Expenses

Calculating with gross income means taking your total revenue and subtracting the cost of goods (COGS). This can also include money that hasn’t necessarily come from the sale of goods. On the other hand, using total revenue means totaling your sales and subtracting the cost incurred from returns.

The tricky part about understanding operating income is what counts as an operating expense. Gross income should be easy to figure out as long as you’re keeping track of your business profits. So what counts as an operating expense?

What Is COGS?

COGS generally refers to the direct cost of producing the goods that you sell. It includes both the raw material cost and the labor that was used at all stages of its production. However, COGS does exclude indirect expenses. This can include any costs related to the logistics of delivering the goods.

COGS is also an important figure when it comes to calculating the gross income that is used for an operating income calculation.

In short, COGS can be seen as the cost of doing business. However, it shouldn’t be confused with operating expenses as they are a separate form of expense. COGS is directly related to the production of goods and should be seen as a distinct figure unrelated to the overall operation of a company.

What Are Operating Expenses?

Operating expenses typically include any cost associated with business operations. For instance, it can include the cost of supplies or bills for the business premises. It also includes factors such as payroll.

Here are some of the most common operating expenses to include in your calculations:

• Administrative expenses (such as utilities and insurance)
• Salaries
• Supplies
• Rent
• Employee benefits
• Marketing and promotions
• Deprecation

These expenses should be easy to identify within your books. 

Operating Income vs. Net Income

Operating income and net income are sometimes used as synonyms. However, these two are separate figures. Operating income will often show all of the business’s income from operations on a daily basis, but it also includes expenses. For instance, it includes factors such as the COGS and operating expenses.

On the other hand, net income takes into account all of your business’s expenses and not just the ones that are important for everyday operations. This can include one-off payments such as lawsuit settlements, refurbishment costs, and also interest payments. So when calculating operating income, it’s important to learn how and why it’s distinguished from net operating income.

What Is Net Operating Income?

While the term is similar, net operating income is typically used in the real estate industry and usually doesn’t apply to regular businesses. To calculate net operating income means to calculate all the revenue received from a property by subtracting operational expenses like maintenance and repairs, but it also includes nonoperating profits and expenses, and it’s also calculated before deducting interest and taxes.

Net operating income is usually known as “earnings before interest and taxes” (EBIT) or just operating earnings.

Does High Operating Income Mean a Company Is Profitable?

Not always. High operating income usually means that a company is profitable, but there may be cases where a business needs to pay more in taxes and interest.

This can be caused by one-time fees or poor financial decisions made by the company. In addition, there may be nonoperating income and nonoperating expenses that aren’t taken into consideration.

This can include interest income, dividend income, or even gains from investments. Since these aren’t considered as operating income, they won’t be included in the calculations.

In short, high operating income can indicate that a company is profitable, but it’s not always the case. It really depends on the type of company and its business model.

Why Is Operating Income Important?

Operating income is an important metric to calculate for a number of reasons:

• Useful for measuring how healthy a business is in terms of its sales and revenue
• Helps to give a clear picture of how much a business is costing and how much profit it actually makes after all expenses are taken into consideration
• Ignores one-time expenses that can skew profit figures. This includes expensive legal settlements or tax bills that can affect accounting for that period
• Makes it easy for investors to see just how well a business is doing before deciding to invest in the company

Operating income is an official Generally Accepted Accounting Principles (GAAP) measure of a company’s financial health. GAAP refers to a common set of principles related to accounting that are issued by the Financial Accounting Standards Board.

It helps to improve the clarity and consistency of financial information, making it easy to compare one document with another. While there are many non-GAAP measurements being used today, most publicly traded companies and large corporations use GAAP to help make it easier to relay financial information between one another.

As one of the most commonly accepted ways of producing financial reports and information, it’s important to use metrics like operating income in order to paint a clearer picture of the health of your business.

It can also be applicable for companies looking to merge with other businesses, or it can be used to identify trends within the business.