WallStreetMojo

WallStreetMojo

WallStreetMojo

MENUMENU
  • Blog
  • Free Video Tutorials
  • Courses
  • All In One Bundle
  • Login
Home » Accounting Tutorials » Income Statement Tutorials » Operating Income

Operating Income

By Madhuri ThakurMadhuri Thakur | Reviewed By Dheeraj VaidyaDheeraj Vaidya, CFA, FRM

What is Operating Income?

Operating Income, also known as EBIT or Recurring Profit, is an important yardstick of profit measurement and reflects the operating performance of the business and doesn’t take into consideration non-operating gains or losses suffered by business, the impact of financial leverage and tax factors. It is calculated as the difference between Gross Profit and Operating Expenses of the business.

In short, it is the Income/profit earned after all expenses except finance cost is adjusted for.

How to Find Operating Income

Some of the popular Operating Income formulae are mentioned below:

1) Operating Income= Gross Profit- Operating Expenses

  • Gross Profit =Net Sales – Cost of goods sold
  • Opex= General Administrative Expenses+ Selling and Distribution Expenses+ Depreciation

2) Operating Income= Net Sales – Direct Cost – Indirect Cost

3) Operating Income= Net Sales – Cost of Goods sold – Operating Expenses

4) Operating Income= Profit After Tax (PAT) + Tax Expenses + Interest Expenses (Finance Cost)

As we can see, all these formulas can be used to derive the Operating Income, and the user can opt for any of the above to calculate Operating Income for the business.

Popular Course in this category
Sale
All in One Financial Analyst Bundle (250+ Courses, 40+ Projects)
4.9 (1,067 ratings)
250+ Courses | 40+ Projects | 1000+ Hours | Full Lifetime Access | Certificate of Completion
View Course

Operating Income Formula

Operating Income Examples

Let’s understand the concept of Operating Income calculation with the help of a few examples:

ABC limited is in the business of making customized gifts. The company reported total sales of $4200 during the year ended Dec 2018. Out of the total sales, $200 was returned to the company on account of defects. The company incurred the cost of goods sold amounting to $3000 during the year in the manufacturing of customized gifts.

Following are the expenses incurred by the company during the year:

Operating Income Example 1

Based on the above information, we can do the calculation.

Operating Income Formula

First, we will find out the Net Sales, Cost of Goods Sold, and Operating Expenses.

Step 1 – Find the Net Sales

Operating Income Example 1

Step 2 – Find the Cost of Goods Sold

Operating Income Example 1-1

Step 3 – Calculate Total Operating Expenses

Operating Income Example 1-2

Step 4 – Find the Operating Income 

Now from the above information, we will calculate the following.

Operating Income Example 1-3

(Remember we have not included Interest and Tax Expenses as they are not included in the calculation.)

Boeing Inc

Let’s understand the same with the help of another operating income calculation example of a large listed company Boeing Inc.

Following are the P&L Account of Boeing Inc for the last 3 years

P&L Account Balance Sheet

source: Boeing Annual Report

From the above screenshot, we can easily see how this Income (Earnings from Operations) of the company has changed over the year 2008 to 2010 and can perform analysis to measure Operational Efficiency.

Operating Income Example 1-1

Points worth noting based on the above analysis:

  • From 2008 to 2010, Revenues increased by 5.58% ( $64306 in 2010 versus $60909 in 2008). However, Interest Coverage Ratio decreased from 19.55 times in 2008 to 9.63 times in 2010. It is important to note that a higher Interest Coverage Ratio is a better sign of the financial health of the business.
  • From 2008 to 2009 Revenues increased by 12.10% ( $68281 in 2009 versus $60909 in 2008); however, Operating Income decreased by $1854 in absolute terms ($2096 in 2009 versus $3950 in 2008) and Operating Profit Margin Ratio decreased from 6.49% in 2008 to a meager 3.07% in 2009.

It helps in understanding the Revenue growth and Profit growth in better terms and helps in making meaningful insights into the business.

Advantages

  • It is used to measure the Operating Efficiency of the business, and by calculating the Operating Income Margin of different businesses, one can compare operational efficiency.
  • Computation is simple and mostly standardized, which leads to an easy comparison between firms as well.
  • It is closely linked and monitored by Banks and Financial Institutions, which provides lending to the business. Various important ratios, such as Interest Coverage Ratio, are derived from Operating Income only.

Disadvantages

  • It excludes Interest Cost and Tax Expenses of the business. It, therefore, is not a correct benchmark for determining the Net value of wealth created by the business for different stakeholders.
  • Certain companies, while calculating Operating Income, sometimes include non-operating items such as gains on Investment. As such, any stakeholder/Analyst must ensure consistency in the calculation method before making any comparison and resultant inferences.
  • It doesn’t find much usage if one is interested in finding the free cash flows of the business as it doesn’t adjust for Interest expenses, which results in cash outflow.

Conclusion

Operating Income is an important yardstick which highlights the operational efficiency of the business and how good management is at turning their efforts into profits. It helps potential investors and lenders of the business to assess how profitable is the business in which they intend to invest/lend as it shows the company’s core business Income and excludes all Non-Operating Income from its purview.

Furthermore, it helps in measuring the operational success of the business and is unaffected by the financial leverage and tax factor. The success of a business is determined by how well a company is managed and it helps in meeting these criteria as it clearly highlights the demand for the business product and services by taking into consideration Sales and also the cost incurred by the business in fulfilling those sales by taking all operating expenses.

Recommended Articles

This article has been a guide to what is Operating Income and its definition. Here we discuss how to calculate operating income with the help of practical examples. You can learn more about accounting from the following articles –

  • List of Operating Expenses
  • Net Operating Income
  • Calculate Operating Cycle
  • Operating Income vs. Net Income
0 Shares
Share
Tweet
Share
Primary Sidebar
Footer
COMPANY
About
Reviews
Contact
Privacy
Terms of Service
RESOURCES
Blog
Free Courses
Free Tutorials
Investment Banking Tutorials
Financial Modeling Tutorials
Excel Tutorials
Accounting Tutorials
Financial Statement Analysis
COURSES
All Courses
Financial Analyst All in One Course
Investment Banking Course
Financial Modeling Course
Private Equity Course
Venture Capital Course
Excel All in One Course

Copyright © 2021. CFA Institute Does Not Endorse, Promote, Or Warrant The Accuracy Or Quality Of WallStreetMojo. CFA® And Chartered Financial Analyst® Are Registered Trademarks Owned By CFA Institute.
Return to top

WallStreetMojo

Download Coursera IPO Financial Model

By continuing above step, you agree to our Terms of Use and Privacy Policy.
WallStreetMojo

Free Investment Banking Course

IB Excel Templates, Accounting, Valuation, Financial Modeling, Video Tutorials

* Please provide your correct email id. Login details for this Free course will be emailed to you

Book Your One Instructor : One Learner Free Class
Let’s Get Started
Please select the batch
Saturday - Sunday 9 am IST to 5 pm IST
Saturday - Sunday 9 am IST to 5 pm IST

This website or its third-party tools use cookies, which are necessary to its functioning and required to achieve the purposes illustrated in the cookie policy. By closing this banner, scrolling this page, clicking a link or continuing to browse otherwise, you agree to our Privacy Policy

Login

Forgot Password?

WallStreetMojo

Free Accounting Course

You will Learn Basics of Accounting in Just 1 Hour, Guaranteed!

* Please provide your correct email id. Login details for this Free course will be emailed to you

Coursera IPO Financial Model & Valuation Free Download