OPERATIONAL PROFIT: CALCULATION, WHAT IT IS FOR AND EXAMPLE - DUDAS - 2025

The operating profit is an accounting value that measures the profit made by a company through its major trading operations, excluding deductions for interest and taxes. This value does not include profits obtained from investments, such as profits from other companies in which the company has a partial interest.

Therefore, the operating profit is different from the net profit, which may change from one year to the next due to the variations of these exceptions made in the operating profit of the company. The concept is used to investigate the profit potential of a company, excluding all external factors.

Operating income is expressed as a subtotal in a company's income statement, after all general and administrative expenses, and before items of interest income and expenses, as well as income taxes.

Operating margin is the operating profit expressed as a percentage of total income.

How it is calculated

Operating profit can be calculated using the following formula:

Operating profit = operating income (sales) - cost of goods sold - operating expenses - depreciation - amortization

Given the existing formula for gross profit: sales - cost of goods sold, then the formula for operating profit is often simplified as: gross profit - operating expenses - depreciation - amortization.

All the expenses that are necessary to keep the business running are included, which is why the operating profit takes into account the depreciation and amortization related to the assets, which are accounting tools that result from the operations of a company.

Operating profit is also known as operating profit, and also as profit before interest and taxes (EBIT). However, the latter can sometimes include non-operating income, which is not part of operating profit.

If a company has no non-operating income, then its operating profit will be equal to EBIT.

Accounts not included in the formula

The operating income does not include investment income generated by a partial interest in another company, even if the investment income in question is directly related to the core business operations of the second company.

Income generated by the sale of assets -such as real estate or production machinery- that are different from those assets created with the purpose of being sold as part of the main business, are not included in the figure of operating profit.

Additionally, interest earned through mechanisms such as checking accounts or money market is not included.

The calculation also does not take into account any debt obligations that must be paid, although those obligations are directly linked to the company's ability to normally maintain its business operations.

What is it for?

The operating profit serves as an indicator of the potential profitability of the business, eliminating from the calculation all factors external to the operation of the company itself. The higher the operating profit, the more profitable will be the main activity of a company

Businesses can choose to present their operating profit figure instead of their net profit figure, since a company's net profit contains the effects of interest and tax payments.

In cases where a business has a particularly high debt burden, operating income may present the company's financial position in a more positive light than net income will reflect.

Positive and negative operating profit

While a positive operating profit may express a company's total profit potential, it does not guarantee that the company is not experiencing losses.

A company with a high debt burden can show positive operating income and, at the same time, have negative net income.

If the operating profit is negative, the company will probably require additional external financing in order to remain in operation.

Managerial indicator

Information from operating income is particularly valuable when analyzed as a trend line. So you can see how a company is operating over a long period of time.

Several things can affect operating profit, such as pricing strategy, cost of raw materials, or labor costs.

Because these elements are directly related to the day-to-day decisions of managers, operational profit is also an indicator of managerial flexibility and competence, particularly during difficult economic times.

Comparison between companies

For investors, the operational profit test allows them to have an easier comparison of companies operating within industries with different tax rates or different financial structures, as this allows for a more equitable comparison.

Some industries have higher labor or material costs than others. For this reason, the comparison of operating profit or operating margin is more meaningful when it is made between companies that are within the same industry.

Therefore, the definition of a "high" or "low" gain must be made within this context.

Example

Walmart Inc. reported an operating profit of $ 20.4 billion for its fiscal year 2017. Total revenue, which was equivalent to its operating income, totaled $ 500.3 billion.

This revenue came from worldwide sales of:

- Walmart physical stores, including Sam's Club.

- E-commerce businesses.

On the other hand, the cost of merchandise sold (CMV) totaled $ 373.4 billion. The sum of operating, selling, general and administrative (GG) expenses totaled $ 106.5 billion.

The company did not explicitly include amortization and depreciation in its income statement.

Therefore, we have:

Operating income - CMV - GG = operating profit

Operating margin

The operating margin, expressed as a percentage, is given as:

Operating profit / operating income x 100 = 4.08%

Net profit

To obtain the net profit, from these $ 20.4 billion of operating profit, the following were subtracted:

- Interest expense of $ 2.2 billion.

- A loss on bad debts totaling $ 3.1 billion.

- A provision for income taxes of $ 4.6 billion.

Finally, a total net profit of $ 10.5 billion results.

References

1. Investopedia (2018). Operating Profit. Taken from: investopedia.com.
2. Investing Answers (2018). Operating Profit. Taken from: investinganswers.com.
3. Steven Bragg (2017). Operating profit. AccountingTools. Taken from: accountingtools.com.
4. MyAccountingCourse (2018). What is Operating Profit? Taken from: myaccountingcourse.com.
5. Gerencie.com (2018). Operational utility. Taken from: gerencie.com.