Because operating income factors into a business’s profits and overall finances, it’s important to understand how it works in order to help you determine your business’s financial standing and make better business decisions.
What Is Operating Income?
The amount of profit a business makes after considering all expenses from operating the business is known as operating income. It is the income reported after the total operating expenses are subtracted from revenue, which is the total income a business earns from sales and non-sales activities such as investments. Operating expenses include direct and indirect costs incurred from running the business such as rent, utilities, inventory, and wages paid to employees. On an income statement, which shows a company’s revenue and expenses for a specific period of time, the operating income is entered after the total revenue and total operating expenses amounts. The operating income amount is calculated by subtracting total operating expenses from total revenue.
Operating Income Formula
Using an income statement, the operating income can be calculated with the information included under the sales and expenses categories. If you have not yet created an income statement, you can calculate your operating income by using this formula: For example, if your sales for the period totaled $570,000 and your recurring, everyday expenses incurred for running the business was $250,000, then your operating income would be $320,000.
Operating Income vs. Operating Profit
Operating income, operating profit, and earnings before interest and taxes (EBIT) are all terms that relate to the earnings of a business. These terms are sometimes used interchangeably as they generally refer to the same concept, though there are slight differences in how each of these terms may be interpreted.
Operating income: The amount after operating costs are deducted from the revenue. Operating profit: Refers to the total net income from business operations, excluding taxes and interest. Also known as EBIT, operating profit is specific to the operating expenses that are listed before taxes and interest on an income statement.
The difference in operating profit and operating income formula is that EBIT also deducts the costs associated with cost of goods sold (COGS), which includes the expenses businesses pay for manufacturing, sourcing, and shipping products or services. EBIT equals the amount after operating expenses and COGS are deducted from the total revenue.
What Is Included in Operating Income?
Operating income includes the amounts directly related to the operational activities of the business. Generally, this includes everyday expenses associated with running the business, and profits, which are gained from the daily sales. Operating expenses include:
RentUtilitiesInsuranceEquipmentPayrollStep costsTravel expensesOffice supplies
Since each business is unique with different goals, the types of income and expenses that constitute operating income can depend on many factors, such as the industry and the product or service provided by the business. Even in the same industry, one business owner may classify certain expenses as everyday expenses, while another might classify them differently.
The Bottom Line
Regardless of how you classify your business expenses, it’s important to understand how operating income is calculated. Understanding how to balance out your incoming sales and your daily outgoing expenses can help you to make better decisions financially and potentially enable you to better allocate income to improve and grow your business. Operating income = revenue – operating expenses EBIT = revenue – operating expenses – cost of goods sold
