Last Updated On June 29, 2021 / Written By Cynthia Vespia

All Things To Know About Net Operating Income

How To Figure Net Operating Income

Increasing income can mean more than just generating sales. There are other measures that can produce an increase in profit, including the following-

Reducing the Cost of Goods
Adjusting food costs and other costs of goods sold (COGS) is a cost-saving measure. This can be achieved by working with suppliers to negotiate a new arrangement with a lower cost. Revised recipes or product design can be an additional cost saver. Reducing cost in this manner keep net profit high.

Reducing Labor Costs
Employee salaries are a high operating cost for most restaurants. These salaries, along with the taxes associated, can reduce the net operating income which comes in. Reducing shift hours or, if necessary, eliminating positions can be a way to increase operating income.

Be More Efficient
Utility companies will work with a business to come up with ways to reduce costs. This can include an energy audit or analysis. The results of such will uncover cost-effective improvements that will help save in monthly expenses. An example would be placing solar panels on the roof of the restaurant to reduce energy costs.

Reduce Operating Expenses
Restaurants can incur a great deal of operating expenses especially in the first few years. Doing an evaluation of all the expenses incurred will help decide which can be reduced. Insurance premiums, food and beverage costs, overhead and supplies can all be reduced. Eliminating unnecessary spending wherever possible will help maximize a restaurant's profits.

Why Is Net Operating Income Important?

Net operating income is often used in real estate as a way to garner the exact value of income from their properties. Those in the restaurant industry also use NOI to operating expense in an effort to increase restaurant profit.

Food and liquor sales are the main revenue factors for a restaurants profitability. However, the operating expenses include maintaining the building including any mortgage payment or rental fees, property taxes, utility costs, employee sales and more.

NOI helps real estate investors determine the value of a property. For restaurant owners, it helps to create an income statement which reflects gross profit and net income. The coverage ratio will then tell any lenders how the restaurant is doing in terms of profitability. Adjustments can be made to sway the profit margin to increase the value.

How To Calculate New Operating Income

The calculation to determine net operating income is to subtract the culumative operating expenses from the total revenue generated. Revenue is any sales made from products sold. Operating expenses include all costs associated with running the restaurant.

Basic Calculation of Operating Costs
Most of the statistics and data of restaurant expenses are gathered by electronic registers and automatically stored in a computer database. Some of the factors needed in the calculations include-

Fixed Costs
These are expenses which don't fluctuate based on sales. rent would be considered a fixed cost as it is the same payment every month. Property taxes and insurance would also be considered fixed costs. Any staff who receives a salaried wage over an hourly one would often be considered fixed cost. However, any staff brought on as a result of business growth would therefore not be fixed cost expenses.

Variable Costs
the costs directly related to the sales volume are referred to as variable costs. Food and beverage costs fall in this category. As do, linens, takeout containers, and most hourly employee wages.

Semi-variable Costs
There are some instances when labor costs will be considered semi-variable costs. Some of the labor is fixed but most are variable, which is where semi-variable comes in. Labor costs are controllable in that hours worked can fluctuate based on business needs.

How To Increase New Operating Income

The goal of any restaurant is to be successful and produce income. Growing the business can go beyond just increasing sales. If the marketplace is overly competitive, it might be more beneficial to increase net operating income instead. This can be achieved by reducing operating costs.

Material Costs
Materials used in packaging and even building materials for the actual restaurant itself can be adjusted. Less expensive material can achieve the same result at a fraction of the cost. Expensive ingredients can be swapped out for something similar or recipes can be changed to reduce the cost of each dish on the menu.

Sub-supplier Costs
Suppliers can be changed until a suitable contract is found. Introducing competitive bidding through sub-suppliers is a way to find reduced costs for supply companies. Negotiations with current suppliers might also find a change in terms for lower prices in the future. In any event, the specifications should be clearly laid out before contracts are signed.

Labor Costs
High labor costs can eat into gross income. Reducing hours is one way to keep labor costs under control. Ensuring no scheduling overlap takes place, and that overtime hours are reduced, can also negate higher costs in the labor pool. The goal is low labor costs with a workforce that is still effective and error-free.

Operating Overhead
High overhead can be costly. Managing labor costs, material costs and sub-suppliers is a way to control operating expenses. Restaurant automated software can make the planning much simpler by providing a transparency of where the money is flowing. Once that is determined, reducing these costs will increase the net operating income.

The Main Factors of New Operating Income

Retained Earnings
This is a portion of the net income which is retained by management for internal operations. Rather than paying the dividends to shareholders these funds are reserved to use as reinvestment in the company.

The calculation for retained earnings starts with the beginning balance and then has the net income added. Any dividends are subtracted from the remaining.

In essence, these funds are the total amount of earnings that have yet to be dolled out to shareholders. Reinvested back through the company in the form of fixed assets or purchases, these funds are often used to pay debt.

Shareholder Equity Impact
The equity that goes to a shareholder is calculated from total assets by subtracting total liabilities. The shareholder portion of the equity is the amount that comes after debts are paid and will then go to the shareholders themselves.

  • Retained earnings (RE) is the net income surplus which is held over. It is often used for reinvestment in the company or to may debt.
  • Any portion of business that has a direct impact on net income can also flow over into retained earnings, cost of goods sold, revenue and sales, operating expenses and more.

Impact of a Negative Decline for Net Operating Income

After a small business or restaurant pays its monthly operating expenses and debts for the month, the net profit is left over. When the net profit is in a state of decline, its a warning that the business is in dire straits. This can impact the overall future of the business if these actions are not put in place.

1. Pay Debts
Paying down debt as fast as possible is important to not get buried under fees too large to meet. Creditors and investors pay attention to financial statements. If looming debt continues to show there is less of a chance for credit to be extended.

2. Signs of Inefficiency
Inefficiency is when a product or service isn't delivered as promised. This can mean quality standards aren't up-to-par or else production is taking too long. Having an inefficient operation can slow down revenue and start to create a decline in net profits. Correcting the problem begins by uncovering where the problem lay before further declining profits begin.

3. Risk and Opportunity Management
Assessing risks
within the business operations is a sound strategy. If net profits are in steady decline it can make handling problems more difficult and lead to a possible breach of important regulations. This can damage the reputation of a business.

4. Lower Owner Salary
Smart small business owners, including those in the restaurant industry, knows that adjusting their own salary can help to ease financial woes. Once debts and other financial obligations are taken care of, the salaries can be reassessed. However, if net profit is still in decline it might be smart move to continue taking a pay cut until the profit margin levels out.

Innovation for Net Operating Income

Case studies over the last five years have seen innovative companies growth was faster than others in their same sector. The innovations see these companies gain the ability to expand into further categories with the promise of higher margins.

Innovative companies obtain these high profit margins due to increased customer awareness and interest. The customers are willing to pay more for a fresh product due to its perceived value over a more traditional approach. New, innovative products often sell more frequently which signals a boost in sales.

Because of this perception, the company can command a higher price tag for the innovative product, technique or service. Packaged with an impeccable campaign complete with standout design and branding, it will entice customers and compel them to act.

Therefore, the companies that embrace more innovative approaches will also enjoy a higher profit margin. More than products, operational innovations are also key to long term profitability at this scale.

Conclusion for Net Operating Income

  • Net Operating Income (NOI) is a value used to calculate the perceived revenue from an investment.
  • NOI is determined after subtracting operating expenses.
  • Reduction of unnecessary costs will help to maximize profits.
  • The formula for garnering the net operating income is by subtracting all operating expenses from the total revenue generated. Revenue includes all sales within a time period. Operating expenses include any costs associated with running the restaurant.