BREAKING DOWN 'Operating Income'
Operating income is a measurement that shows how much of a company's revenue
will eventually become profit. Operating Income is a synonym for earnings before interest and taxes (EBIT) and is also referred to as "operating profit" or "recurring profit."
Operating income is calculated as: Operating income = gross income - operating expenses -
depreciation - amortization
The measure of operating income excludes items such as investments in other firms, taxes and
interest expenses. In addition, nonrecurring items such as cash paid for a lawsuit settlement are not included. Operating income is required to calculate
operating margin, which describes a company's operating efficiency.
BREAKING DOWN 'Profit'
Profit is the money a business makes after accounting for all expenses. Regardless of whether the business is a couple of kids running a lemonade stand or a publicly traded
multinational company, consistently earning profit is every company's goal. As a result, much of business performance is based on profitability in its various forms. Some analysts are interested in top-line profitability, whereas others are interested in profitability before expenses, such as taxes and interest, and still others are only concerned with profitability after all expenses have been paid.
There are three major types of profit that analysts analyze: gross profit, operating profit and net profit. Each type of profit gives the analyst more information about the company's performance, especially when compared against other time periods and industry competitors. All three levels of profitability can be found on the income statement.
Gross, Operating and Net Profit
The first level of profitably is gross profit. Gross profit is sales minus the cost of goods sold. Sales is the first line item on the income statement and the cost of goods sold, also referred to as CGS, is generally listed just below it. For example, if company A has $100,000 in sales and a CGS of $60,000, it means the gross profit is $100,000 minus $60,000, which is $40,000. Divide gross profit by sales for the gross profit margin, which is $40,000 divided by $100,000, or 40%.
The second level of profitability is operating profit. Operating profit is calculated by deducting operating expenses from gross profit. Gross profit looks at profitability after direct expenses, and operating profit looks at profitability after operating expenses. These are things like salaries, general and administrative costs, also referred to as SG&A. If company A has $20,000 in operating expenses, the operating profit is $40,000 minus $20,000, equaling $20,000. Divide operating profit by sales for the operating profit margin, which is 20%.
The third level of profitably is net profit. Net profit is the income left over after all expenses, includes taxes and interest, have been paid. If interest is $5,000 and taxes are another $5,000, net profit is calculated by deducting both of these from operating profit. In this example the answer is $20,000 minus $5,000, minus $5,000, which equals $10,000. Divide net profit by sales for net profit margin, which is 10%.
