How to Calculate Operating Income Step-by-Step

Understanding Operating Income

Operating income is a financial metric that reveals the profitability of a company’s core business activities before considering certain financial and tax obligations. This metric is also known as operating profit or Earnings Before Interest and Taxes (EBIT).

Analyzing operating income helps assess how efficiently a business manages its day-to-day operations. It provides insight into the company’s ability to generate earnings from its primary revenue-generating activities. Operating income specifically excludes non-operating income, interest expenses, and taxes, allowing for a focused view on core business strategies.

Key Components for Calculation

Calculating operating income requires specific financial figures typically found on a company’s income statement. The primary components include revenue, cost of goods sold, and operating expenses.

Revenue, often called sales, represents the total income a business generates from selling its goods or services. This is the starting point on an income statement, reflecting the gross proceeds from a company’s primary activities.

Cost of Goods Sold (COGS) includes the direct costs involved in producing the goods or services a company sells. These costs encompass raw materials, direct labor, and manufacturing overhead directly tied to production.

Operating expenses are the costs a business incurs to keep its daily operations running, excluding COGS. These are often categorized as selling, general, and administrative (SG&A) expenses. Common examples include salaries for administrative staff, rent, utilities, marketing and advertising costs, office supplies, and depreciation of non-production assets.

Step-by-Step Operating Income Calculation

To calculate operating income, you begin with the total revenue generated and then subtract both the cost of goods sold and operating expenses. The formula is: Operating Income = Revenue – Cost of Goods Sold – Operating Expenses.

First, locate the company’s total revenue on its income statement, which is typically presented at the very top. Next, identify the cost of goods sold (COGS), which is usually the first expense item listed immediately after revenue. Subtracting COGS from revenue yields the gross profit, an interim profitability measure.

Following this, identify all operating expenses. These include categories like selling, general, and administrative (SG&A) expenses, which often appear below gross profit on the income statement. Summing up all these operating expenses provides the total operational costs incurred by the business.

Finally, subtract the total operating expenses from the gross profit to arrive at the operating income. For example, if a business has $500,000 in total revenue, $200,000 in cost of goods sold, and $150,000 in operating expenses, the calculation would be: $500,000 (Revenue) – $200,000 (COGS) – $150,000 (Operating Expenses) = $150,000 (Operating Income).

Differentiating Operating Income

Operating income provides a specific view of a company’s earnings, setting it apart from other profitability metrics like gross profit and net income. Each metric offers distinct insights into a company’s financial performance.

Gross profit is calculated by subtracting only the cost of goods sold from revenue. It reflects the profit generated directly from sales before accounting for any other business expenses. Operating income takes this a step further by deducting operating expenses from gross profit, providing a more complete picture of profitability from core operations.

Net income represents the “bottom line” profit, meaning it includes all revenues and expenses. While operating income excludes interest expenses, taxes, and non-operating income or expenses, net income incorporates all of these. Therefore, a company can have positive operating income but a negative net income if interest, taxes, or other non-operating costs are substantial.