Operating Earnings

Operating Earnings Definition

Operating Earnings or Operating Income is the amount of profit a company earns after deducting operational direct and indirect costs from sales revenue. It is also known as EBIT i.e. earnings before interest and taxes. We don’t consider Interest and Taxes and other non-operational income while calculating Operating Income.

Explanation

Operating Earnings is the number of profits that the company earns from its core operations. It is one of the important concepts which help the investors and creditors to know about the profit that the company is generating from its core business.

In order to calculate the operating profit of the company, we need to understand and distinguish between various types of costs and how they appear in our Income StatementIncome StatementThe income statement is one of the company's financial reports that summarizes all of the company's revenues and expenses over time in order to determine the company's profit or loss and measure its business activity over time based on user requirements.read more. There are three types of financial statementsTypes Of Financial StatementsThere are three types of financial statements, i.e., Balance Sheet, Income Statement and Cash Flow Statements. These written records facilitate the analysis and comparison of an organization's financial position and performance.read more that a company prepares, Income Statement, Balance Sheet, and Cashflow Statement. Income Statement shows the profitability of the company. Balance sheets SheetsA balance sheet is one of the financial statements of a company that presents the shareholders' equity, liabilities, and assets of the company at a specific point in time. It is based on the accounting equation that states that the sum of the total liabilities and the owner's capital equals the total assets of the company.read more show the Assets and Liabilities of the company. And the use of the Cash flow statement is to know about cash inflows and outflows of the company. Operating Profit is a part of the Income Statement of the company.

Operating-Earnings

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Source: Operating Earnings (wallstreetmojo.com)

Operating Earnings Formula

There are three formulas to calculate Operating Earnings:

1. Operating Earnings = Total Revenue – COGS – Indirect Costs 
2. Operating Earnings = Gross Profit – Operating Expense – Depreciation & Amortization
3. Operating Earnings = EBIT – Non- Operating Income + Non- Operating Expense

How does Operating Earnings Work?

The Operating Profit works as per the below order. We have a Sales revenue figure from which we reduce COGSCOGSThe cost of goods sold (COGS) is the cumulative total of direct costs incurred for the goods or services sold, including direct expenses like raw material, direct labour cost and other direct costs. However, it excludes all the indirect expenses incurred by the company.read more, i.e., the cost of goods sold, which includes Raw material cost, wages cost, etc. to get Gross Profit. Other Operating expenses such as Rent, Insurance cost, depreciation, etc. are reduced from Gross ProfitGross ProfitGross Profit shows the earnings of the business entity from its core business activity i.e. the profit of the company that is arrived after deducting all the direct expenses like raw material cost, labor cost, etc. from the direct income generated from the sale of its goods and services.read more to get Operating profit figures.

There is another method to calculate Operating profits. We can start from the bottom of the income statement, i.e., take the Net Profit figure and add back Interest expense and Taxes to get the operating profit of the company.

How does Operating Earnings Work

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Source: Operating Earnings (wallstreetmojo.com)

Example

There is a Shoe Manufacturing Company, calculate Operating Profit from below provided information.

Sales Revenue $3,00,00,000 Cost of Goods Sold $1,00,00,000 Marketing & Sales Expense $20,00,000 Office and Admin Cost $10,00,000 Depreciation Cost $20,00,000 Interest Cost $10,00,000 Tax rate 30%.

Solution

Calculation of Operating Earnings

Operating Earnings Example 1

The Operating Earnings = Total Revenue – COGS – Indirect Costs 

  •  = 3,00,00,000 – 1,00,00,000 – (20,00,000 + 10,00,000 + 20,00,000)
  • = 1,50,00,000
Operating Earnings Example 1.1

Operating Income = Gross Profit – Operating Expense – Depreciation & Amortization

  • = 2,00,00,000 – (20,00,000 + 10,00,000) – 20,00,000
  • = 1,50,00,000
Operating Earnings Example 1.2

Operating Income = EBIT – Non-Operating Income + Non-Operating Expense

  • = 1,50,00,000 – 0 + 0
  • = 1,50,00,000

Net Profit

Example 1.3
  • =14000000-4200000
  • Net Profit = 9800000

Importance

It is an important indicator of how business is performing. It is also used in calculating various financial ratiosFinancial RatiosFinancial ratios are indications of a company's financial performance. There are several forms of financial ratios that indicate the company's results, financial risks, and operational efficiency, such as the liquidity ratio, asset turnover ratio, operating profitability ratios, business risk ratios, financial risk ratio, stability ratios, and so on.read more.

Creditors, Investors, and Management closely monitor the EBIT of the company to track the company’s performance. This is an important aspect to consider while making a decision to invest as investors can compare the different companies at their operating level.

Operating Profit is an indirect measure of the Company’s profitability. Higher the operating income, the more profitable a company is.

Conclusion

Hence, Operating Earnings is an important concept which helps to know about the company’s financial health. Although Net Profit plays an important role in understanding the company’s financial health if we are comparing companies with different tax structures and finance structures, then the Operating profit will give us a more accurate picture.

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