Operating income is the amount of profit left after considering all operating expenses and subtracting those expenses from the company’s revenue. This type of income is listed on the income statement, which includes a summary of a business’s revenue and expenses for a specified period.
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.
- Operating income is equal to the amount of revenue earned by the business minus operating expenses.
- On an income statement, the operating income is listed after all sales and expenses are calculated.
- Operating income, operating profit, and earnings before interest and taxes (EBIT) all refer to business earnings and are often used interchangeably—but there are slight differences.
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.
To get an accurate amount on the bottom line, it’s important to keep records of all sales and expenses and create income statements for each period.
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:
- Step costs
- Travel expenses
- Office 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.
When creating your income statement, you can decide how to classify your expenses. For example, you can break down your administrative, selling, operating, and general expenses in the expenses section of your income statement. It’s critical to document and include these expenses so your net income calculations are accurate.
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.
Frequently Asked Questions (FAQs)
How do you calculate net income?
Net income appears at the bottom of the income statement and refers to the amount after all expenses are deducted from revenue. To calculate this on an income statement, you’ll need to report all revenue from sales and all expenses, including interest and taxes. Once this is filled out on the income statement, you’ll see the net income amount on the bottom line.
Are operating income and EBIT the same?
Operating income and EBIT generally refer to the same concept regarding a company’s earnings. Operating income is more general, in that, it is equal to revenue minus operating expenses. EBIT is more specific as it also subtracts the cost of goods sold from the revenue. Hence the difference in formulas:
Operating income = revenue – operating expenses
EBIT = revenue – operating expenses – cost of goods sold
What is the difference between operating income and revenue?
Operating income and revenue differ as they represent different aspects of a business’s finances. Revenue is the amount made from sales and services, usually in the form of payments from clients or customers. Operating income is the amount from the revenue after the operating expenses are considered.