Operating Income Formula

Formula to Calculate Operating Income

Operating income Formula (also referred to as EBIT formula) is a profitability formula that helps in the calculation of a company’s profits generated from core operations. The formula is a decision tool for an investor to calculate how much gross income will eventually result in profit for a company. The operating income can be calculated by deducting the cost of goods sold and operating expenses from total revenue.

Mathematically, operating income can be calculated using two methods

Method 1

Method 2

Alternatively, the Formula for operating income can also be calculated by adding back interest expense and taxes to the net income (adjusted for non-operating income and expense), which is mathematically represented as,

Steps to Calculate Operating Income

Method 1

For the first method can be calculated in the following four simple steps:

Step 1: Firstly, the total revenue has to be noted from the profit and loss account. For example, in a manufacturing company, the total revenue will be computed by multiplying the number of units produced with the average price per unit.

Total Revenue = Number of Units Produced * Average Price Per Unit

Step 2: Now, the cost of goods sold is also available in the profit and loss account. It is calculated by adding the raw material purchase during the accounting period to the beginning inventory and then deducting the closing inventory.

Cost of Goods Sold = Beginning inventory + Purchase of raw material – Closing inventory

Step 3: Now, the operating expenses are also gathered from the profit and loss account. It includes various direct and indirect costs like labor cost, depreciation, administrative expenses, etc.

Step 4: Finally, the EBIT is arrived at by deducting the values derived in Step 2 and Step 3 from the value in Step 1, as shown below.

EBIT = Total revenue – Cost of goods sold – Operating expenses

Method 2

On the other hand, the following four steps help in the calculation of the Operating Income by using the alternate method:

Step 1: Firstly, the net income has to be captured, which is easily available in the profit and loss account as a line item. Make sure that non-operating income (deducted) and expense (added back) have been adjusted as these are not part of the core operation.

Step 2: Now, the interest expense is also available in the profit and loss account. It is the product of the effective rate of interest and outstanding borrowing across the year.

Step 3: Now, the taxes are also collected from the profit and loss account.

Step 4: Finally, the EBIT is derived by adding back the values derived in Step 2 and Step 3 to the value in Step 1, as shown below.

EBIT = Net income + Interest expense + Taxes

Calculation Examples of Operating Income

Let’s see some simple to advanced examples of EBIT to understand it better.

Example #1

Let us consider an example to calculate EBIT for a company called ABC Limited, which is in the business of manufacturing customized roller skates for both professional and amateur skaters. At the end of the financial year, the company has generated $150,000 in total revenue along with the following expenses.

In the below-given Screenshot is the data used for the Calculation of Operating Income

For the calculation of Operating Income, we will use the following values first.

Cost of Goods Sold

Net Income

Therefore, Net income = $41,000

ABC Limited’s net income at the end of the financial year stood at $41,000.

Now, Using the first method to calculate Operating Income is as follows –

i.e. EBIT = $150,000 – $70,000 – $25,000

EBIT will be –

So, EBIT = $55,000

Now, we will do the calculation of Operating Income using the second method mentioned above.

i.e. EBIT = $41,000 + $10,000 + $4,000

EBIT will be –

So, EBIT = $55,000

Example #2 (Apple Inc)

Let us take the real-life example of Apple Inc.’s annual report as on September 29, 2018. The following information is available:

The calculation of Operating Income will be as follows –

Therefore,

• EBIT (in Millions) = Net income + Interest expense + Tax – Non-Oper. Income
• EBIT = $59,531 + $3,240 + $13,372

Operating Income will be –

• EBIT = $70,898

Operating Income Calculator

You can use the following EBIT Calculator.

 

Relevance and Use

EBIT is basically a profitability metric that helps to assess how a company is performing which is calculated by measuring profit before payment of interest to lenders or creditors and taxes to the government. This is a profitability calculation which is measured in terms of dollars and not in percentages like most other financial terms.

However, there remains a limitation of the operating income formula that it is particularly useful when comparing similar companies in the same industry. Since the EBIT formula only measures profit in terms of dollar amount, investors and other financial users usually find it difficult to use this metric to compare differently sized (small & medium enterprise, mid-corporate and large corporate) companies across the industry.

Calculate Operating Income in Excel (with template)

Now let us take the Apple Inc.’s published financial statement example for the last three accounting periods. Based on publicly available financial information the EBIT (in dollar terms) of Apple Inc. can be calculated for the accounting years 2016 to 2018.

In below-given screenshot is the data for the calculation of EBIT using both the formula mentioned above.

Calculation of Operating Income using the first formula.

EBIT = Total revenue – Cost of goods sold – Operating expenses

So EBIT for Sep 29, 2018, will be –

Similarly, we will calculate the EBIT for  Sep 30, 2017, and  Sep 24, 2016

Calculation of Operating Income using the Second formula.

EBIT = Net income + Interest expense + Taxes

So the Income for Sep 29, 2018, will be –

Similarly, we will calculate the EBIT for  Sep 30, 2017, and  Sep 24, 2016

From the above table, it can be seen that the EBIT of Apple Inc. in dollar terms has been growing during the period which is a positive sign for the company.

Recommended Articles

This has been a guide to Operating Income Formula. Here we discuss how to calculate Operating Income using practical examples along with downloadable excel templates. You may learn more about Financial Analysis from the following articles –

• Calculate Operating Cash Flow
• LTM EBITDA
• EBIT vs Net Income