Operating income is the amount of profit made from a company’s business operations after accounting for operating expenses. These might include the cost of goods sold, cost of production, cost of sales, cost of labour, or inventory.
Essentially, it is the amount of revenue left after all operating expenses are deducted. If there is revenue that doesn’t come from the primary operating activities of the business, then it can’t be included in the operating income of the business.
For example, if a soap manufacturing company was able to generate extra income by investing in real estate property, then the revenue from the sale or leasing of the real estate property will not be added to the operating income of the company because the real estate investment is not part of their primary operating activities of making soap.
The operating income is usually listed at the end of the operating section of a multi-step income statement as income from operations. The operating section is presented first, before the non-operating and income tax sections of the income statement.
Operating income shows how much a company is making from its operations. Investors can look at the operating income and compare with similar companies to determine if a company is making enough. Companies with increasing operating income show that the company is decreasing its operating costs or increasing its gross income by expanding its operations.
Operating Income Formula
According to the formula, the operating income is the difference between the gross income and operating expenses. Companies looking to increase their operating income can do so by increasing their gross income or by reducing their operating expenses, or both.
Decreasing operating income is an indication that a company is losing its operating efficiency or it has added operating costs.
Operating income is obtained from gross income by subtracting the operating expenses. The operating expenses include office supplies and utilities and rent. Gross income is obtained by subtracting the cost of goods sold from the total revenue.
It should be noted also that operating expenses only involve the expenses that go directly to the primary operation of the business, such as rent, payroll, inventory, utilities, etc. Operating expenses do not include depreciation or amortization.
Operating Income Example
A luxury soap manufacturing company, Trea, has decided to calculate its operating income for the year 2019. That year, they sold 780,000 units of soap at $8 per unit. The cost of production of one unit of Trea soap is $2.5. In 2019, Trea spent $79,000 on rent.
Utility bills at the end of the year were at $231,000. Payroll, inventory and other Operating expenses were $480,000. Trea also made additional income from the sales of their old equipment worth $25,000. Trea also donated $22,000 to GreenAll, a non-profit organization. What is the operating income for Trea?
Let’s gather our data from the question. Since none of the information is given directly, we will have to calculate each one separately.
Gross income is found by taking the total revenue (780,000 x $8) and subtracting the cost of goods sold (780,000 x $2.5).
- Gross income = $4,290,000
Let’s also find the operating expenses by adding the rent ($79,000), utility bills ($231,000), and other operating expenses ($480,000)
- Operating Expenses = $790,000
Now that we know our operating expenses and gross income, we can now calculate our operating income using our formula:
So the operating income of Trea is $3,500,000.
As you can see, sometimes the information you need to calculate the operating income may not be straight forward. You’ll need to first determine the gross income and operating expenses before calculating your operating income.
Operating Income Analysis
Notice how the calculation in the example above didn’t include the sales of the old equipment or the one-time donation to the non-profit organization. Investors like operating income because it does not include taxes or any other expenses or income that does not come from the core operations of the company.
It clearly shows how efficient the company is at converting raw materials into profit and regarding the other expenses that are attached to the production.
It is important to note that operating income is the income that a company makes from its operations. This means that it excludes any income or expenses that are not directly tied to its operations. Investors analyse operating income and they always prefer a company with increasing results This is because it shows they are able to increase revenue while controlling production and overhead costs.
Operating income is similar to earnings before interest and taxes (EBIT) since both look at the amount of money a company is able to make at the end of a period. However, operating income differs from EBIT because operating income doesn’t include income or expenses outside of the core operational activities of the company while EBIT does.
Calculating operating income is also useful when a business wants to compare its present performance to its past performance. Companies wishing to do so can compare their present and previous operating incomes and see if they are doing better or worse.
Operating Income Conclusion
- Operating income is the amount of money a company makes from its operations only, not including other income or expenses.
- This formula requires two variables: gross income and operating expenses.
- Operating income is used to determine if a company is managing its overhead costs and production costs well.
- Investors prefer companies with increasing operating income because it shows that the company is managing its production and overhead costs well.
- Operating income can be calculated by taking the difference between the gross income of a company and its operating expenses.
- While similar to EBIT, it differs because operating income doesn’t include extra income or expenses.
Operating Income Calculator
You can use the operating income calculator below to quickly calculate a company’s profit from operations by entering the required numbers.
1. What is operating income?
Operating income is the amount of money a company makes from its operations. This means that it excludes any income or expenses that are not directly tied to its core operational activities.
2. How do you calculate operating income?
To calculate the operating income of a company, you will need to know its gross income and its operating expenses. Once you have these two numbers, take the difference between them and this will give you your company’s operating income.
The formula for calculating operating income is:
Operating Income = Gross Income − Operating Expenses
3. Is operating income the same as profit?
No, operating income is not the same as profit. Operating income measures the amount of money a company makes from its operations while profit measures the total amount of money a company has made including all its income and expenses.
4. What is a good operating income?
A good operating income varies from company to company. However, investors generally prefer companies with an increasing operating income as it shows that they can manage their production and overhead costs well. For most businesses, an operating margin higher than 15% is considered excellent.
5. How do you increase operating income?
Some ways a company can increase its operating income include increasing its gross income, controlling its operating expenses, and improving its operational efficiency.