What is Operating Profit? Expert Tips on Calculating It

Research suggests that data-driven managers experience year-over-year growth in operating profit by 86%. According to the study, 32% agree that they have improved financial budgeting accuracy. They also achieved a two times greater year-over-year increase in the operating cash flow. This explains the importance of calculating operating profit.

What is operating profit? Operating profit(OP)is an accounting statistic. It calculates the company’s profit from its core business operations. This is before excluding the deduction of interest and taxes.

It also ignores the profits from the company’s subsidiary investments. For example, the business revenue from another company which has your firm as its shareholder.

Operating profit helps understand how well you are managing costs. An OP calculator helps in understanding whether you have a sustainable business model. Comparing your business’s performance with your competitor’s is also made easy with operating profit.

Here, you will learn how to calculate operating profit using the operating profit formula. You will also come across advantages of operating profit and examples of financial performance.

Let’s Understand What is Operating Profit

As a business, making money is crucial. Generating business revenue alone cannot decide your firm’s financial performance. It needs to keep track of its margin. Now, a margin is the difference between a good’s selling price and the cost of production. The costs related to the making and selling of goods are called “cost of goods sold”.

The operating profit margin is an essential financial margin to track. It is a useful financial KPI. Everything used for the company’s operating profit calculation is relevant to its financial health.

OP is a trusted indicator of a business’s health. The main reason is that it eliminates external factors from the calculation. All the expenses required to carry out the business operations are included. Include depreciation and amortisation related to properties for that reason. These are accounting tools developed from the corporation’s activities.

The non-operating income that OP excludes is as follows:

1. Sales of capital assets
   
2. Profits gained from foreign exchange transactions
   
3. Dividends and investment gains

Apart from that, OP also removes non-operating expenses such as:

1. Interest payments on company debts
   
2. Costs related to acquisitions, mergers and restructuring
   
3. Lawsuit settlements

OP is also known as operating income. Sometimes, people also refer to it as Earnings Before Interest and Tax (EBIT). However, OP is different from EBIT.

Unlike OP, EBIT can also contain income from non-operational activities. Let’s say, your company doesn’t have any non-operating income.  Then, your OP will be the same as EBIT.

OP only considers the revenues and costs linked with a business’s core activities. Thus, it is a more reliable measure of operating profitability than similar KPIs like EBIT.

How to Calculate Operating Profit

Before understanding the operating revenue formula, you should be aware of two components. They are as follows:

Gross Income

Gross income is the total amount of money that your business makes after sales. This is the total income before reducing the interest payments, taxes and other business expenses. Make sure to measure gross income accurately. This is because it is the first step of calculating OP as well as taxes.

The gross income formula is as follows:

Gross Income = Gross Revenue – Cost of Goods Sold (COGS)

Here, gross revenue is the total revenue made in sales before any deduction. COGS is the amount spent in the production stage. COGS depends on the working activities of the industry you are working in. Some expenses under COGS are:

1. Money for purchasing raw materials
2. Labour costs
3. Costs for packaging material
4. Shipping charges

Operating Expenses

Operating expenses are the costs a business incurs to run its day-to-day operations. These include rent, utilities, salaries, marketing, insurance, and administrative expenses. Unlike the cost of goods sold (COGS), which is directly tied to production, operating expenses cover the broader costs of maintaining business functions. Managing these expenses effectively is crucial for improving (OP) and overall financial health. This depends on various factors such as:

1. The industry your business is a part of
2. The product or goods you are selling
3. Various departments within your business

However, here are some of the most common operating expenses:

1. Rent
2. Maintenance fees
3. Employee payroll
4. Marketing fees
5. Supplies and utilities

1. Rent: Rent is a fixed expense businesses pay for office spaces, retail stores, or manufacturing units. It directly impacts overhead costs and must be managed efficiently to maintain profitability.
2. Maintenance Fees: These costs cover repairs, equipment servicing, and facility upkeep. Regular maintenance ensures smooth operations, prevents breakdowns, and extends the lifespan of assets.
3. Employee Payroll: Salaries, wages, and benefits paid to employees fall under this category. Payroll is one of the largest operating expenses and plays a crucial role in workforce motivation and productivity.
4. Marketing Fees: Advertising, promotions, and digital marketing expenses help businesses attract customers and boost sales. A well-planned marketing strategy ensures a strong return on investment (ROI).
5. Supplies and Utilities: Costs for office supplies, electricity, water, internet, and phone services are essential for daily operations. Efficient management of utilities can help reduce unnecessary expenses and improve profit margins.

Please note that capital and non-operating expenses are not a part of this category. Capital expenses are the high-value investment made by your business. They offer benefits for over a year. Purchasing fixed assets like equipment, machines and buildings are examples. It can be non-physical assets like trademarks or patents as well.

Non-operating expenses, as you already know, are expenses connected with daily operations. These include costs of relocating buildings, interest payments etc.

So, how to calculate operational profit or loss? The operational profit or loss formula is as follows:

Operating Income = Gross Income – Operating Expenses
Or
Operating Profit = Gross Revenue – (Operating Expenses + Cost of Goods Sold)

Example

Let’s say, you run a pastry shop. Apart from that, you also take delivery orders for customized birthday cakes. Now, you are planning to expand your business. For that, you need a business loan. You will have to produce operating income to the investors and creditors for availing loan.
Looking at your finances, you realise that your business has made a total income of Rs.5,00,000. The expenses you made were as follows:

Expenses	Amount
Insurance	Rs.50,000
Power	Rs.15,000
Property	Rs.30,000
Wages	Rs.40,000
Transit	Rs.30,000
Supplies	Rs.15,000
Repairs	Rs.20,000
COGS	Rs.1,00,000

Gross Income = Gross Revenue – Cost Of Goods Sold
= Rs.5,00,000 – Rs.1,00,000
= Rs.4,00,000

Operational Expenses = Rs.50,000 + Rs.15,000 + Rs.30,000 + Rs.40,000 + Rs.30,000 + Rs.15,000 + Rs.20,000
Operational Expenses = Rs.2, 00,000

Operating Income = Gross Income – Operational Expenses
= Rs.4,00,000 – Rs.2,00,000
= Rs.2,00,000

You can now present to investors that your business made a profit of Rs. 2,00,000 last year.

High-profit income is a good sign. However, that may not always guarantee profitability. There is another case that you should consider. Your company can still be running at loss despite making money through sales.

For example, your company generates good revenue by selling products. But, you lose a large portion of profits because of high-interest payments and taxes. Or it can also be due to the company’s poor financial decisions and unwanted expenses.

Also Read : Net Profit: Understanding Its Significance for Your Business

Why Operating Profit is Important?

Operating profit is a crucial financial metric that reflects a company’s ability to generate earnings from its core business operations. Unlike net profit, which includes taxes and interest expenses, OP focuses solely on revenue and essential costs, providing a clearer picture of a company’s operational efficiency. A high OP indicates strong financial health, while a low or declining profit may signal inefficiencies or rising costs.

Investors and stakeholders use OP to evaluate a company’s profitability and growth potential. Since it excludes non-operating factors like one-time gains or losses, it helps in making informed business decisions. Companies with consistent operating profits are often seen as stable and well-managed, making them more attractive to investors.

OP is a key financial indicator that measures a company’s ability to generate earnings from its core business activities. It is calculated using the operating profit formula:

OP = Gross Profit(GP)– Operating Expenses(OE)

Understanding how to calculate OP helps businesses assess their financial health and efficiency. A strong operating profit shows that a company is managing its expenses well and generating sustainable revenue.

Another crucial metric is the operating profit margin, which is calculated as:

Operating Profit Margin = (Operating Profit / Revenue) × 100

This percentage helps businesses compare profitability across different periods or industries. A higher margin indicates strong cost control and efficient operations, while a lower margin suggests potential financial challenges. By monitoring operating profit and optimizing costs, companies can improve profitability and long-term growth.

Advantages of Using Operating Profit

Operating profit is the money left with the company to meet needs such as:

1. Paying taxes
2. Clearing debts
3. Taking care of liabilities
4. Paying dividends

1. Paying Taxes: A portion of the OP is used to fulfill tax obligations, including corporate income tax and other government levies. Proper tax management ensures compliance and avoids legal issues.
2. Clearing Debts: Companies use OP to repay loans and interest, reducing financial liabilities. A strong operating profit helps maintain a good credit rating and financial stability.
3. Taking Care of Liabilities: Profit covers business obligations such as rent, utilities, and supplier payments. Managing these liabilities efficiently ensures smooth operations and avoids cash flow issues.
4. Paying Dividends: Profitable companies may distribute a part of their operating profit as dividends to shareholders. This rewards investors and enhances the company’s reputation in the stock market.

Thus, it benefits company managers and third-party entities like investors in many ways. Here’s how:

Managers

Cost management provides valuable insights into the efficiency of controlling expenses within an organization. By analyzing cost control measures, businesses can assess how effectively they are managing their financial resources. This evaluation helps in identifying areas where costs can be optimized without compromising productivity or quality.

A key aspect of cost management is comparing current expenses with past financial data, including operating profit, working expenses, and revenue costs from previous years. This comparison highlights trends, inefficiencies, and opportunities for improvement, allowing businesses to make informed financial decisions and enhance overall profitability.

Managers can make a number of important financial decisions with this information. You can correct many financial mistakes. You can develop plans to increase the profitability of the business.

Investors

Investors can analyze a company’s management decisions by looking at OP. You can also learn whether the company can carry out its everyday operations efficiently. Based on this, you can make wise decisions about investing in the business.

Other than profitability, OP can reveal a few things about a company. The trends in operating income decide a company’s responsiveness and flexibility to changes. Flexibility and responsiveness are two determining factors of management efficiency.

Operating income and net income are different from each other. Operating income excludes interest payments and taxes. On the other hand, net income includes them. Thus, operating income is a better and more reliable measure than net income. That is if analysing the core profitability of your firm is your aim.

You can also use the operating income to make comparisons with competitors and draw insights. This is if factors like business models, market capitalization and operations’ scale remain similar.

Related Read: Business to Business: What Is B2B

Key Takeaway

The income statement notes your OP. You can get an idea about this and expenses incurred by analyzing the statement. This will help in assessing the company’s working efficiency. It gives insights into the financial health of a firm.

You can compare it with the financial performance of other years. Based on this, make a note of potential and mistakes to make better decisions. OP also facilitates comparisons with the profitability of competitors.

OP is a crucial financial metric that reflects a company’s profitability from its core operations, excluding non-operating income and expenses. It provides valuable insights into operational efficiency, cost management, and overall business performance. By accurately calculating operating profit, businesses can assess their financial health, make informed strategic decisions, and identify areas for improvement.

To optimize OP, experts recommend focusing on cost control, revenue growth, and efficient resource allocation. Regularly analyzing financial statements, streamlining operations, and leveraging technology can enhance profitability and ensure long-term success. Understanding and improving OP is essential for sustaining a competitive edge in today’s dynamic business environment.

Let’say, you are looking for a company’s core in-service income. Then, you should first separate non-operating profits and expenses from net income. Operating income is a significant part of our daily lives. It is used for creating both household budgets and company balance sheets.

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