Calculating Operating Profit
What is Operating Profit?
The total earnings from a company's core business activities is where the operating profit comes from. Also called operating income, the final operating income gross will only include earnings before interest and tax (EBIT).
Operating profit takes out mitigating factors that skew income variables from a financial analyst to reveal accurate financial health indicators.
Understanding the Use of Operating Profit
Operating profit includes all assets involved in business operations. Companies have the choice to show a financial analyst the figures from an operating profit rather than net profit figures.
Net profit carries the effects of any taxes and interest payments a company has accrued. If there's a higher debt visible through the net profit, using the figures from the operating profit can present the financial health of a company in a more positive light.
Knowing the operating profit tell business owners where their cash flow stands. This provides insight into revenue that's being accrued before interest payments and tax payments are made. Once that baseline is established, the company has a better understanding of expenses for materials; salaries; rent; etc.
Operating profit allows presents a clear understanding of how efficient cost control is at the company. Comparing yearly figures on the financial statements highlights how the pricing strategy set forth is working. These comparisons of the operating profit over time shows a financial analyst and potential investors how flexible the company is in gearing towards profit.
When looking at similar companies in a specific industry, the numbers from the operating profit will provide investors needed information. For example, the operating income gross will show how a company stacks up to its competitors. Operating profit is a quick indicator of the choices made by management on a daily basis and whether they are flexible with change.
Operating Profit Calculation Formula
The formula for calculating operating profit can be done one of two ways.
- Operating Profit = Operating Revenue - Cost of Goods Sold ( COGS) - Operating Expenses - Depreciation - Amortization
- Gross Profit - Operating Expenses - Depreciation - Amortization
- Add together income to determine the gross revenue. (revenue)
- Add cost of labor and materials (COGS)
- Round up the rest of the operating expenses such as utilities, rent, marketing, etc.)
- Determine any depreciation or amortization of assets.
- Subtract the COGS, operating expenses, and total depreciation/amortization from the revenue.
Revenue from sales that are not part of the core business will not be included with the overall operating profit figure. Also, interest accrued from business savings accounts is excluded as well. Operating income also won't include investment income from a secondary company even if the earnings are directly linked to the core business. Real estate sales won't be permitted either.
What Can Be Included in Operating Profit
The following is a list of possible items to factor into a operating profit formula-
What Shouldn't Be Included in Operating Profit
These elements should be left out when calculating the equation for business operating profit-
Conclusion of Operating Profit
- Operating profit is the revenue that remains after direct and indirect costs are deducted from sales figures.
- Operating profit is different from net profit and gross profit (also known as gross income). However, the operating profit margin is a calculation based on net and gross figures.
- Earnings before interest and tax (EBIT)is when the operating profit does not include operating revenue.
- Operating profit allows presents a clear understanding of how efficient cost control is at the company.