What is Income from Operations Formula?
Operations from income formula is used to calculate the operating income of the business where the same can be calculated by deducting the cost of goods sold and other operating expenses which can be direct or indirect from the amount of sales revenue generated in the business.
The Income from Operations can be termed as Earnings Before Interest and Taxes (i.e. EBIT) or operating profit, is the amount of revenue or amount of profit that is left post deducting the costs which are indirect and direct operational from the sales revenue.
Income from Operations = Gross Profit – Operating Expenses – Depreciation
Where,
Operating expenses can include rent, wages, commissions, general and administrative expenses, marketing expenses, etc.
Explanation
The formula for income from operations looks simple but requires bifurcating expenses into operating expenses and non-operating expenses and those sometimes become difficult to do so if the firm is involved in multiple businesses. However, the formula states that all the expenses that are incurred to run the business should be deducted from the gross revenue which shall yield us a profit figure which states that can be earned while doing that particular business.
It avoids including interest, tax and another finance cost as those are although expenses to the firm but are incurred to finance the business and where the firm raises those funds and at what rate of interest is the choice of the management and that expense has nothing to do with running the business and hence it is avoided.
Depreciation is actually capital expenditure that is already incurred by the firm but because of matching concept and the benefit that is derived from those expenditure benefits in future as well, hence its spread out and since those expenses are incurred to run the business and therefore depreciation expense should be considered while calculating operating income.
Examples
Example #1
MQF manufacturing company reports the below figures and has asked you to calculate its income from operations.
You are required to calculate operating profit based upon the above figures.
Solution:
Here, we will first calculate the gross income of the firm.
Gross Income = Gross Revenue – Cost of goods sold = 50,00,000 – 32,50,000 = 17,50,000.
We can use the above formula to calculate income from operations.
Rent expense, marketing expenses, and administrative expenses are all part of operating expenses. Hence, the total of operating expenses will be 300,000 + 500,000 + 150,000 which shall be 950,000. Depreciation expense is NIL here.
Calculation of income from operations can be done as follows:
Income from Operations =1,750,000 – 950,000 – NIL
Income from Operations will be –
Income from Operations = 800,000.
Example #2
DHFL one of the listed companies in Sensex is facing a crash in its stock price. One of the analysts who was not covering the stock has started coverage and wants to analyze whether the stock truly has indeed any problems hiding inside it. He has extracted an income statement of 2 quarters from the publicly available information:
You are required to calculate income from operations for both the quarters and advise if the company’s operating income is on decreasing trend?
Solution:
Here, we can see there are many variables in the income statement, however, those have been abbreviated to wider heads.
We shall not consider other income, tax, and interest while calculating the operating income. We can use the above formula to calculate income from operations.
Here we just need to deduct expenses from sales and then depreciation.
Calculation of income from operations for sep – 18 can be done as follows:
Income from Operations = 3,515.66 – 434.29 – 11.86
Income from Operations for Sep – 18 will be –
Income from Operations = 3069.51.
Calculation of Income from Operations for Dec – 18 can be done as follows:
Income from Operations = 3,250.94 – 361.01 – 13.10
Income from Operations for Dec – 18 will be –
Income from Operations = 2876.83.
Hence, it appears that the company is indeed experiencing slow down in its business as the profit has declined.
Example #3
RIL industries are one of the leading companies in the nation and have been expanding in many various businesses. The company has reported a good net profit for the year ended in 2018.
Based on upon income statement, you are required to calculate the operating income or income from operations.
Solution:
Calculation of income from operations can be done as follows:
Income from Operations = 81877 – 39450 – 16706
Income from Operations will be –
Income from Operations = 25721.
Now we shall first calculate the gross income of RIL which will be deducted all the direct expenses from sales figure, then we shall calculate total of operating expenses (indirect in operating business) and we are already given depreciation expenses and when we deduct the same from the difference of gross profit and operating expenses, we shall get income from operations as shown in table.
Hence, income from operations of RIL is 25,721.
Relevance and Uses
Operating income is a critical indicator of how a firm is operating efficiently. This is an indirect yardstick of productivity and a firm’s ability to generate more of its core earnings, which further can be used for expansion of the business. investors generally monitor this figure closely in order to assess the firm’s trend of efficiency over a time period.
Like net profit and gross profit, operating profit is a key financial metric that is used by the stakeholders to determine the worth of the firm for a potential takeover or buyout. The greater the operating profit as time decays, the more effectively the firm’s core business will be carried out.
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