Operating Income vs Net Income

Difference Between Operating Income and Net Income

The key difference between operating income and net income is that operating income refers to the income earned by a business organization during the period under consideration from its principal revenue-generating activities and does not consider non-operating income and non-operating expenses, whereas, net Income refers to earnings of the business which is earned during the period after considering all the expenses incurred by the company during that period.

Both are essential metrics in the financial accounting statements. Operating income is the income generated by the day to day operations or, in other terms, the core activities of a business. It is calculated after deducting the cost of operations from the total sales.

Mathematically, it can be expressed as:

Operating Income = Gross Income – Operating Expenses – Depreciation & Amortization

Net income is the bottom line. It is the final profit available for the shareholders after deducting interest expenses, any extraordinary income or expense, and taxes.

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For eg:
Source: Operating Income vs Net Income (wallstreetmojo.com)

Mathematically, it can be expressed as:

Net Income = Operating Income + Other Income – Interest Expense + One-Time Extraordinary Income – One-Time Extraordinary Expense – Taxes 

The above equation helps us identify the relationship between operating income and net income. Operating income, on the one hand, identifies the income generated from the operating activities of the business; net income, on the other hand, quantifies any income generated by the business entity either from operations or from interests earned from investments or even an income generated by liquidating an asset.  Operating income is a subset of a bigger umbrella called Net income.

Example

Consider the income statement of an ABC company.

Total Net Sales1,000,000
Credit Income
Total Revenue1,000,000
Cost and Expenses
Cost of Goods Sold600,000
Administrative Expenses50,000
Depreciation and Amortization10,000
Total Costs and Expenses660,000
Operating Income340,000
Other Income50,000
Interest Expense-45,000
One-Time Loss-50,000
Income before Taxes295,000
Taxes59,000
Net Income236000

Here operating income has been calculated by deducting the cost and expenses from the total sales. However, to calculate net income, total expenses are deducted from total income, and then tax is levied. Also, as illustrated, net income is the bottom line, and the final number on the income statement as one follows the top-down approach. Operating income is just a subset used in calculating the net income.

Operating Income vs. Net Income Infographics

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For eg:
Source: Operating Income vs Net Income (wallstreetmojo.com)

Critical Differences Between Operating Income and Net Income

The key differences are as follows –

#1 – Significance

Operating income is the most significant section in the income statement of any business unit. It is because it helps in identifying the income generated from the primary business activities of the firm. It does not consider any one-time expense or any one-time income. Hence it is free from any manipulations and gives a clear picture of the robustness of the operational activities of the business. Analysis of operating income for consecutive quarters can help an investor identify the profitability of the business and the growth opportunities it can provide for the long term.

Net income, on the other hand, is the final profit available for the shareholders after all expenses and income have been taken care of. Hence it is called a bottom lineBottom LineThe bottom line refers to the net earnings or profit a company generates from its business operations in a particular accounting period that appears at the end of the income statement. A company adopts strategies to reduce costs or raise income to improve its bottom line. read more and used to pay out the dividends. Unlike operating income, it does contain any one-time expense or one-time income. For example, consider a pharma company that has a robust operating income but has been penalized by regulators. This one-time payment will not affect the operating income but will impact the net income and eventually, the profit available to the shareholders. Investors should carefully analyze both incomes before parking their money.

# 2 -Taxes and uses

Operating income only takes care of revenue generated and the cost of operations.  Net income takes care of not only revenue, costs, expenses, but also one-time expenses, taxes, and surcharges. Therefore, sometimes you might see a big number on the operating income section of the balance sheetBalance SheetA 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, which gets completely wiped off in the bottom line. Since net income denotes the profitability of the firm, it is used in calculating parameters like EPS, return on equityReturn On EquityReturn on Equity (ROE) represents financial performance of a company. It is calculated as the net income divided by the shareholders equity. ROE signifies the efficiency in which the company is using assets to make profit.read more, and return on assets. Shareholders are mainly interested in these ratios, as these will only determine if their investments have been worthwhile.

Comparative Table

BasisOperating IncomeNet Income
DefinitionThe operating income signifies the income generated from the primary operational activities of the business for a particular period.Net income is the income generated inclusive of all activities carried by the business unit for a particular period.
Significance It helps in identifying how much revenueRevenueRevenue is the amount of money that a business can earn in its normal course of business by selling its goods and services. In the case of the federal government, it refers to the total amount of income generated from taxes, which remains unfiltered from any deductions.read more transforms into Profit.It identifies the earning potential of the business entity.
Calculation Operating income = GrossIncome = GrossThe difference between revenue and cost of goods sold is gross income, which is a profit margin made by a corporation from its operating activities. It is the amount of money an entity makes before paying non-operating expenses like interest, rent, and electricity.read more Income – Operating Expense – Depreciation and amortization.Net income = Operating income + Other income – Interest expense + one-time extraordinary income – onetime extraordinary expense – Taxes
Taxes Taxes are not considered in Operating income.Net income is derived after considering taxes.
Uses It is used to calculate return on capital employedReturn On Capital EmployedReturn on Capital Employed (ROCE) is a metric that analyses how effectively a company uses its capital and, as a result, indicates long-term profitability. ROCE=EBIT/Capital Employed.read more.It is used to calculate ratios such as earning per shareEarning Per ShareEarnings Per Share (EPS) is a key financial metric that investors use to assess a company's performance and profitability before investing. It is calculated by dividing total earnings or total net income by the total number of outstanding shares. The higher the earnings per share (EPS), the more profitable the company is.read more, return on equity, return on assets, etc.

Final Thought

Both operating income and net income are essential parameters while judging the financial health of the firm. Long term investors will be more interested in understanding the robustness of the core business activities of the firm. Hence they will monitor the operating income with a close eye. However, short term traders will be more interested in the bottom line numbers as that will determine the earning potential of their speculative bets.

That is why most of the time, you will see a sharp dip in the share price of a listed firm whenever there are some short-term setbacks like losing a lawsuit or penalized by regulators. Most of the time, these are an overreaction by the short-term traders who are concerned about near term profitability, and most often than not, share prices do bounce back. For example, the Maggi ban in India had a massive impact on Nestle India Ltd shares, which dropped by 50% in 4 weeks before bouncing back to their initial levels within 2 quarters.

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