How To Calculate Operating Income

By Indeed Editorial Team

Updated March 31, 2021 | Published February 4, 2020

Updated March 31, 2021

Published February 4, 2020

Operating income is your company's earnings before taxes and interest. If you would like to have an accurate idea of the way your business is operating, then you will need to know what your operating income is. Operating income will give you an idea of your company's core profitability and the success of your management. In this article, we discuss what operating income is, the importance of calculating your business' operating income and how to calculate it with examples.

What is operating income?

Operating income is the amount of profit that a company has left over after they deduct the direct and indirect operational costs from sales revenue. Operational costs are wages, depreciation and cost of goods sold including rent, marketing, equipment, payroll, supplies and other items that may be needed to operate your business.

It is important to note that operating income does not include items such as other income, non-operating expenses and non-operating income. Operating income is different from net income and gross income because operating income accounts for more expense line items than gross income and less expenses than net income.

What is the importance of operating income?

Operating income is important to small and large businesses for various reasons. Each business will likely have its own business goals and profit margins they would like to meet with operating income. Here are the most common reasons why operating income is important:

  • It serves as an indirect measurement of how efficient your business is or will be in the future. The higher your operating income in your business, the more profitable your company is.

  • Analyzing your business' operating income is helpful to investors and other shareholders in your company because it doesn't include items that might skew profits.

  • It demonstrates how well your management controls expenses, overhead and production costs while generating more revenue.

  • It enables you to analyze operating profitability as a measure of performance

  • You can begin to assess where you stand in comparison to the competitors within your industry

  • Calculating your operating income on a periodic basis will help you to identify trends in your business and possible economic fluctuations.

When companies experience declining operating income, they have less money for owners, debt reduction and business growth. Lenders and shareholders observe operating income closely because dividends must be paid out to shareholders using money generated by selling a product or providing a service.

Operating income may fluctuate with economic conditions, but it is important to calculate your operating income regularly to identify trends and patterns for historic value to determine the reason behind an increase or decline in operating income.

How to calculate operating income

Operating income is calculated by taking a company's total revenue subtracted by the cost of goods sold, which is equivalent to gross income and subtracting all operating expenses. Operating income excludes taxes or interest income or expenses from investments and is required to calculate the operating margin, which will provide you with your company's operating efficiency. The formulas you can use to calculate operating income are:

Basic formula:

  • Operating income = Gross income - Operating expenses

In-depth formulas:

  • Operating income = Gross income – Operating expenses – Depreciation – Amortization

  • Operating Income = Revenue - Cost of Goods Sold (COGS), Labor and other daily expenses

Operating income examples

Your business will likely have its own specific net sales and operating expenses. The example below outlines how to identify and calculate operating income using the sample income statement below. Using this table, we can see that operating income results from the gross income or gross margin from XYZ Company's yearly sales statement of $62.9 million minus operating expenses of $36.3 million.

For example, the figures in the table plugged into the formula would look like this:

  • $26,599= $62,908 - $36,309

XYZ Company Yearly Income Statement (in millions)
Net sales:
Net product sales $ 70,080
Net service sales 18,908
Total net sales 88,908
Cost of sales:
Products 15,000
Services 11,000
Total cost of sales 26,000
Gross margin 62,908
Operating expenses:
Marketing 4,332
Fulfillment 10,766
Research and development 12,540
Other operating expenses 8,671
Total operating expenses 36,309
Operating income $ 26,599

Other examples

Many companies use operating income to measure the operational success of their business. These examples display how operating income can be used to gain insights into the efficiency of your company and its profitability.

  • Example: Walker Shoes, a shoe company, reports that their income has risen by 10% each year to $10 million during the last two quarters of the fiscal year. Walker Shoes realized the increase in operating income and revenue after using the operating income formula. The operating income and revenue increased due to a rise in online shoe sales throughout the last two quarters of the year. The rise in sales was due to marketing and IT efforts to attract buyers and increase the functionality of the company website.

  • Example: Black Company reports financial results for the first quarter of its fiscal year and notices that their operating income has increased by 26% as compared to the same quarter last year. This rise in operating income is important to present to shareholders because they are going to vote on a potential merger with Company Blue in the next few weeks. Although Black Company's sales fell by 4% in the first quarter, their operating income growth may provide shareholders with the confidence they need to vote on the merger of Black Company and Company Blue.

  • Example: Mary contacts her accountant to gather her financials so she can calculate her operating income to make sure she is compliant with her business loan agreement. She would like to complete her loan and interest payments and keep in good standing with her bank as her company grows. Her company results are as follows:

    • $1,000,000 in revenue

    • $250,000 in cost of goods sold

    • $200,000 in operating expenses.

    • Operating income = $1,000,000 – ($250,000 + $200,000) = $550,000

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