What is operating income?

Operating income looks at revenue minus operating expenses, to give a glimpse of a company’s profit and general efficiency.

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Key Takeaways

  • Operating income = revenue - operating expenses

  • It’s the same as EBIT, earnings before interest and taxes, on a company’s income statement

  • You can use it to gauge a manager’s success in hard economic times

  • Net operating income is the same calculation, except for a real estate investment

Operating income provides a snapshot of a company’s profit and how efficiently it’s running business operations. It’s calculated as the company’s income minus operating expenses. Operating expenses include employee salaries and other costs related directly to the production of goods.

A company’s operating income differs from its profit, which also includes non-operating expenses, such as income taxes and debt. It’s also different from gross income, a number that includes non-sales income.

Investors and financial analysts consider operating income when deciding which stocks to invest in because it gives you a clue to a company’s general cash flow.

You can find operating income on a company’s income statement, usually on the line called “Earnings before interest and taxes” or EBIT. EBIT is a standard accounting measurement for profitability. By excluding taxes and interest (debts), you eliminate information that makes it hard to compare companies in different areas or industries. A company’s operating income and EBIT are the same.

You certainly shouldn’t make investing decisions based on operating income alone, but it does give you a way to judge company profits (or losses) at a glance.

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How to calculate operating income

The operating income formula is as follows:

Operating income = revenue - operating expenses

Revenue, also called net sales, is the income earned within a given period of time. It includes the value of returns and other store credits. If you sold eight books this month at a price of $25 each, your revenue for the month is $200. If one of those books was returned during the month, your revenue would drop to $175.

Operating expenses cover all the day-to-day costs that a company incurs. That includes labor and the cost of goods sold (COGS), which is the direct cost of producing and selling a company’s goods. So if you’re selling physical books, your COGS will include the cost of your ink, paper, the binding process, etc.

Where to find a company’s operating income

You can find all of the information for a company’s operating income on its income statement. Also known as a profit and loss statement, this document is one of the three financial statements that publicly traded companies must release each quarter. All together, these documents include a lot of important profit numbers.

Since operating income is the same as EBIT, you can just use the “Earnings before interest and taxes” line on an income statement instead of doing your own calculations.

Why operating income is important

Operating income shows you the most relevant financial information for determining a company’s profit: how much money it’s making and how much it costs to run the business.

This measurement excludes non-operating expenses. Those expenses include a company’s interest expenses, such as bond payments and credit the company owes, and its corporate tax bill. These aren’t necessarily a direct result from the day-to-day running of the business. They also vary greatly by industry and where the company operates. Many of these financial numbers, like a company’s tax bill, are also unlikely to make or break a business on their own.

Because operating income disregards more variable financial information (like taxes), you can use it to compare companies. It’s harder to compare across industries, since company financials differ by industry, but you can still compare how efficient companies are with their money and their general cash flow.

Operating income also allows you to compare how well managers and executives are handling a company’s day-to-day affairs. In particular, you can get an idea of how well the management is performing during tough economic times.

Net operating income

Net operating income (NOI) is a calculation on the profitability of an income-generating real estate investment. It’s the same as the calculation for operating income, except that it focuses on real estate. NOI is calculated as the revenue from a property minus its operating costs:

Net operating income = property revenue - property operating expenses

The most common source of property revenue is rental income. Operating expenses can include rent, utilities, and the salaries of property employees, such as a landlord. Like a company’s operating income, NOI excludes taxes and interest payments on loans. It also excludes depreciation, amortization, and capital expenditures.

NOI is useful to real estate investors because they can quickly get an idea of the net profit from an investment. They can also compare properties in different areas, even though local factors, like property taxes, may differ.