What is Operating Income?
Operating income is the profit generated by the business after deducting operating expenses, such as administration costs, depreciation and wages. It represents the profit a company makes from its regular business activities.
The operating income is the net income that is not affected by any non-operating expenses, such as taxes or interest expenses. Therefore, it provides a more accurate view of a company's ability to generate cash from its core operations.
Operating Income Formula
Operating income is calculated by subtracting the total operating expenses from the total gross income.
Operating income = Gross income – Operating Expenses
Operating income can be used to determine how well a business is performing. If a company's operating income is consistently increasing over time, then the firm is possibly generating greater revenues in relation to its expenses.
On the other hand, if the company's operating income is decreasing over time, then the firm's expenses are growing faster than their revenues.
The following two formulas are also generally used to determine operating income:
- Operating income = Total Revenue – Direct Costs – Indirect Costs
- Operating income = Gross Profit – Operating Expenses – Depreciation – Amortization
Operating income shows a company’s profitability after accounting for its operating expenses, but before accounting for interest and tax. Net income is the amount of money that remains after all operating expenses, including taxes and interest charges on loans are accounted for.
Although net income is a common term used to describe a company's total earnings, operating income is a better measure of a company's financial performance.
This is because investors use operating income to measure a company's efficiency and profitability without taking into account interest expenses or tax rates — both of which are influenced by external factors.
Example of Operating Income Calculation
Consider a manufacturing firm that generated a total revenue of $45 million in the first quarter of this year.
During that period, administrative and staff salaries totaled $4 million, raw materials and goods cost $12 million, and depreciation and amortization came to $1 million.
Given that operating income is the amount of profit after all company expenses have been accounted for, we will use the following formula:
Operating Income = Total Revenue – Wages – Cost of Raw Materials – Amortization and Depreciation
Operating Income = $45M - $4M - $12M - $1M
Based on this calculation, we can determine the manufacturing firm's operating income during that time — which turns out to be $28 million in profits.
The next section discusses how to find and calculate operating income from the income statement of a company.
How to Find Operating Income?
Operating income is one of the key components in the income statement that measures the efficiency of a company. The profitability of any company can be gauged using operating income. In other words, operating income gives a view of the degree to which a company is able to absorb the fixed costs and convert them into profits.
In the example below, we demonstrate how to find and calculate operating income by using Apple's income statement for the quarter ending June 29, 2019.
Operating Income = Gross Income (in the case of Apple, it is Gross Margin) - Operating Expenses.
Which means, $20.22 billion minus $8.68 billion.
From this formula, we can find that the operating income of Apple for the quarter ending June 29, 2019 is $11.54 billion (shown in blue in the table below).
Source: Investopedia
Operating Income vs. EBITDA
Operating income and EBITDA are both useful metrics that are used for assessing the financial performance of a company.
Operating income refers to the income that a company generates from its core business operations. This operating income can be calculated by subtracting the operating expenses from the total revenue generated by those core operations. The calculation of operating income can provide insight into where a company's profits come from and how much it spends on its overheads. The following formula can be used to calculate it:
Operating income = Gross income – Operating Expenses
Similar to operating income, EBITDA also excludes interest and tax expenses. EBITDA stands for Earnings Before Interest Taxes Depreciation and Amortization.
- Earnings is defined as the profit a company makes after deducting the cost of doing business. Interest is the amount that the company pays in interest on loans.
- Taxes is the amount that the company pays in taxes.
- Depreciation is the amount that the company pays for the loss in value of assets over time and amortization is the amount that the company pays in amortization cost.
EBITDA = Net Income + Interest + Taxes + Depreciation + Amortization
While EBITDA reflects the potential profit of a company, operating income measures the actual profit earned by that company as a result of its business operations.
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