OPERATING INCOME: WHAT IT IS AND EXAMPLES - DUDAS - 2024

The operating revenues or operating are an accounting figure that measures the amount of profit made by the business operations of a business, after deducting operating expenses, such as salaries, depreciation and cost of goods sold.

Operating income takes the gross income of a company, which is equal to total income minus the cost of merchandise sold, and subtracts all operating expenses.

Source: pixabay.com

The operating expenses of a company are the costs that are incurred by normal operating activities. These include items such as office supplies and utilities.

Operating income is an indicator of profitability. It tells investors how much income will eventually turn into profit for a company.

Normally, the income statement declares this calculation at the end of the operations section, calling it operating income. This section is always presented before the non-operating and income tax sections for the calculation of net income.

What is operating income?

Operating income is similar to a company's earnings before interest and taxes (EBIT). They are also known as operating profit or recurring profit.

The only big difference between operating income and EBIT is that EBIT includes any non-operating income that the company generates. Operating income is calculated as:

Operational income = Gross income - Cost of merchandise sold - Operational expenses.

Operational expenses include all costs associated with executing core business activities. For example, selling, general and administrative expenses, depreciation and amortization, and other expenses.

On the other hand, they exclude items such as investments in other companies (non-operating income), taxes and interest expenses.

Furthermore, non-recurring items, such as accounting adjustments, legal judgments or one-time transactions, are not included. Neither are other items in the income statement that are not directly related to the company's core business operations.

Operating income is required to calculate the operating margin, which describes the operating efficiency of a company.

Operating income and net income

Keep in mind that just because a company shows a profit in the final balance of the year does not mean that the company is healthy. In reality, it could mean the opposite.

For example, a business might be losing customers and downsizing. As a result, they are liquidating their teams and making huge profits. Major activities are losing money, but equipment sales are making money. This business is clearly not healthy.

Importance

Operating income is important because it is considered a critical indicator of how efficiently a business operates. The higher the operating income as time goes on, the more profitable a company's core business will be.

They are an indirect measure of productivity and a company's ability to generate more profits, which can then be used to further expand the business.

They also allow you to analyze operating profitability as a unique indicator of performance. This analysis is particularly important when comparing similar companies in a single industry. This is because those companies may have different capital structures or tax environments.

It is also important to note that some industries have higher labor or material costs than others.

This is the reason that the comparison of operating income or operating margins is generally more meaningful between companies within the same industry. The definition of a "high" or "low" ratio must be made within this context.

For management

Several things can affect operating income, such as pricing strategy, raw material prices, or labor costs.

However, as these elements are directly related to the day-to-day decisions that managers make, operating income is also an indicator of managerial flexibility and competence, particularly in difficult economic times.

For investors

This is an important concept because it gives investors and creditors an idea of ​​how well basic business activities are performing. Separate revenue, operating and non-operating expenses, to give external users a clear idea of ​​how the company makes money.

Investors closely monitor operating income to assess the efficiency trend of a company over a period of time.

Operating income provides investment analysts with useful information to evaluate the operating performance of a company. Interest expense or tax rates, two variables that can be unique from one company to another, are not taken into account.

Operating income, as well as gross profit and net profit, are key financial indicators used to determine the value of a business for a potential purchase.

Examples

Example 1

Many companies focus on operating income when measuring the operational success of the business.

For example, ABC Company, a hospital and drug firm, reports an increase in its operating revenue of 20% per year to $ 25 million during the first two quarters of its fiscal year.

The company saw an increase in its revenues and operating income due to an increase in patient volume in the two quarters.

The increase in patient visits was driven by two of the company's new immunotherapy drugs - one to treat lung cancer and the other for melanoma.

Example 2

In another example, we have Company Red, which reports financial results for the first quarter of its fiscal year. The company saw an increase in operating income by 37% compared to the same period last year.

The report of the increase in operating income is especially important because the company is looking to merge with the Blue Company, and shareholders are scheduled to vote next month on the possible merger.

While Company Red's first quarter sales fell 3%, its operating income growth could potentially give Blue Company shareholders the confidence to vote and merge the two companies.

Example 3

We are going to consider the following income statement presented by Company XYZ.

Using this information and the formula above, it can be calculated that Company XYZ's operating income is:

Operating income = $ 1,000,000 - $ 500,000 - $ 250,000 - $ 50,000 = $ 200,000.

Operating income as a percentage of sales is called operating margin. In this example, Company XYZ earns $ 0.20 in operating income for every $ 1 in sales.

References

1. Will Kenton (2018). Operating Income. Investopedia. Taken from: investopedia.com.
2. Investing Answers (2019). Operating Income. Taken from: investinganswers.com.
3. CFI (2019). Operating Income. Taken from: corporatefinanceinstitute.com.
4. Harold Averkamp (2019). What is operating income? Accounting Coach. Taken from: accountingcoach.com.
5. My Accounting Course (2019). Operating Income. Taken from: myaccountingcourse.com.