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:
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.
Mathematically, it can be expressed as:
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.
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Consider the income statement of an ABC company.
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
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 line 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 sheet, 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 equity, and return on assets. Shareholders are mainly interested in these ratios, as these will only determine if their investments have been worthwhile.
|Basis||Operating Income||Net Income|
|Definition||The 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 revenue transforms into Profit.||It identifies the earning potential of the business entity.|
|Calculation||Operating income = Gross 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 employed.||It is used to calculate ratios such as earning per share, return on equity, return on assets, etc.|
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.
This article has been a guide to Operating Income vs. Net Income. Here we discuss the top difference between Operating Income and Net Income along with infographics and comparison table. You may also have a look at the following articles –