Definition
Operating income, also known as operating profit or operating earnings, is a measure of the profits a company generates from its core business operations, excluding deductions of interests and taxes. It’s calculated by subtracting operating expenses, cost of goods sold (COGS), and depreciation from gross income. It provides an accurate indicator of a firm’s profitability and operational efficiency.
Phonetic
The phonetic pronunciation of “Operating Income” is: “op-uh-rey-ting in-kum”.
Key Takeaways
Sure, I can do that. Here are the three main takeaways about Operating Income.
- Operating income refers to the profits realized from a business’s ongoing operations and excludes any earnings derived from other sources like investments or legal settlements. Also known as Operating Profit or Operating Earnings, it’s a significant measure of financial performance which enables investors or business owners to see how well a company manages its operating costs.
- Operating income is calculated by subtracting the cost of goods sold (COGS), operating expenses, and depreciation from gross income. A high operating income is favorable as it means that the business has strong operational management. If the operating income is low or negative, it indicates inefficiency in controlling costs or expanding the company’s sales.
- Beyond providing insights into a business’s operational efficiency, operating income also indicates how much cash a business has to cover its non-operating expenses, such as interest on borrowed capital. Hence, it is important for stakeholders as it gives them an idea of the company’s operational profitability and liquidity.
Importance
Operating income is a critical business and finance metric because it measures a company’s profitability derived directly from its core business operations. This performance indicator reflects the amount of revenue that remains after deducting all operating costs, such as costs of goods sold (COGS), wages, and depreciation, excluding taxes and interest payments. As such, it serves as a clear indicator of the firm’s operational efficiency and profitability before any overhead costs. This figure is often used by internal management, investors, and creditors to assess business performance, compare it to industry peers, and inform strategic decisions around pricing, budgeting, and investments. Hence, operating income is a vital financial measure demonstrating the health and future sustainability of a business.
Explanation
Operating Income, often referred to as operating profit or operating earnings, serves as an essential KPI (Key Performance Indicator) that captures a company’s core profitability stemming from their day-to-day operations. It is a measure of the profit realized from a business’s operational activities and excludes any earnings or expenses not directly tied to the central operations, such as interest expenses, taxes, or income from investments. It resides within the income statement and is reached by subtracting cost of goods sold and operating expenses from gross profits.By concentrating on the business’s basic activities, operating income provides key insights into the efficiency with which a company manages its costs and utilize its resources to generate profit. Investors, creditors, and management use it as a critical tool for analyzing the financial performance and stability of the business. It helps distinguish companies that are proficient at managing their operations from those which are not, providing a more transparent view of a company’s health by ruling out financial activities and other incidental, non-recurring, or extraordinary items. This level of analysis is crucial for comparing a company to its competitors within the same industry.
Examples
1. **Apple Inc.** – In their 2020 fiscal year, Apple Inc. reported an operating income of $66.29 billion. This indicates the profits they earned from their primary business operations – production, sales and services of computers, iPhones, and other tech devices – after subtracting operating expenses such as cost of goods sold, employee wages, and research and development costs.2. **Amazon.com Inc.**: Amazon.com Inc. reported an operating income of $22.9 billion for the year 2020. This was calculated after subtracting operating expenditures such as the cost of making and shipping products, fulfillment center and warehouse expenses, marketing, and technology spend from the revenue they earned from their e-commerce operations, cloud services, and other sources.3. **Starbucks Corporation** – For the fiscal year ending in September 2020, Starbucks reported an operating income of $1.37 billion. This reflects the earnings from their primary business operations of selling coffee, beverages, and food items in their stores globally after deducting their operating costs including the cost of sales, store operating expenses, and general and administrative expenses.
Frequently Asked Questions(FAQ)
What is Operating Income?
Operating Income is a measurement of the profit associated with the regular, core business operations of a company, excluding any income and expenses from non-operating activities, tax services, and interest expenses.
How is Operating Income calculated?
Operating Income is calculated by subtracting the cost of goods sold (COGS), operating expenses, and depreciation from a company’s gross income. The formula is Operating Income = Gross Income – Operating Expenses – Depreciation – Amortization.
Why is Operating Income important?
Operating Income is important because it provides insight into a company’s operating efficiency. It offers a clear picture of the company’s profitability from its core operations, before the subtraction of interest and taxes.
Is Operating Income the same as Operating Profit?
Yes, Operating Income is also known as Operating Profit. They both refer to the profit that a company makes from its core business operations.
Can Operating Income be negative?
Yes, if a company’s operating expenses exceed its gross income, the operating income can be negative. This is often a sign of trouble, indicating that a company is not profitable from its primary operations.
How does Operating Income differ from Net Income?
Operating Income only considers revenues and expenses from core business operations, while Net Income includes all other sources of revenue and expenses, such as interest and taxes.
How can a company improve its Operating Income?
A company can improve its operating income by increasing revenues, reducing cost of goods sold, controlling operational costs or a combination of these.
Does Operating Income include taxes and interest expenses?
No, Operating Income does not include taxes and interest expenses. It only considers revenues and costs associated with a company’s primary, core business activities.
Is Operating Income reflected on a company’s income statement?
Yes, the Operating Income is usually reported on a company’s income statement, just below the Gross Profit line. It is hence also often referred to as ‘Income from Operations’.
Does high Operating Income always mean a healthy company?
Not necessarily. While a high operating income is generally positive, it does not consider the company’s debt levels or taxes. Therefore, a company with high operating income can still have a low (or negative) net income.
Related Finance Terms
- Gross Profit
- Operating Expenses
- Earnings Before Interest and Taxes (EBIT)
- Net Profit
- Revenue
Sources for More Information
