Companies earn revenues from their operations. However, they must also incur expenses to generate sales. The difference between both these represents the profit or income for a company.
Another term used to describe this income or earnings is profits. Companies measure these profits at regular intervals to establish the profitability of their operations. In some cases, they may also make a loss when the expenses exceed revenues.
Profits are also significantly crucial for stakeholders, in particular shareholders and investors. These profits represent the earnings they can get if the underlying company decides to distribute them.
However, some companies may not allow those profits to shareholders. Despite that, a profitable company can provide returns to investors in the form of capital gains on investments.
However, profits do not only include the difference between revenues and all expenses. There are several variants to these earnings that can provide critical information.
For example, these may involve gross profits that deduct the cost of sales from net sales. Similarly, it consists of the operating income or profit. This income can have other variants, such as the after-tax operating income. Before discussing that, however, it is crucial to understand operating income.
What is Operating Income?
Operating income is the profit a company earns after deducting its operating costs from revenues. This income comes from subtracting direct and indirect expenses from net sales.
Apart from the above method, companies can also use other formulas for the operating income. For example, companies can calculate it by deducting operating expenses, depreciation, and amortization from gross profits.
Operating income is a highly crucial metric for companies and their stakeholders. This income is also a part of various ratios and metrics that can provide critical insights into a company’s operations.
Companies can understand how much earnings they generate from their activities through this metric. In some instances, this income is more critical than the net or gross income.
However, operating income does not represent all the income a company receives from selling its products or services. Revenues represent any income generated by a company through sales only.
It is the top line that appears in the income statement. In contrast, operating income deducts operating expenses from those revenues. Usually, it comes in the income statement after gross profits and operating expenses.
Apart from revenues, operating income requires operating expenses. Usually, these include selling and general and administrative expenses.
Apart from those, depreciation and amortization are deductions from revenues to achieve operating income. However, these do not include non-operating expenses, for example, taxes, interest, etc. The cost of goods sold is also crucial for calculating operating income. However, it may already be a part of gross profits.
Overall, operating income represents companies’ total earnings from their operations. This process involves deducting depreciation, amortization, and operating expenses from revenues.
Other names used for operating income include Earnings before Interest and Tax (EBIT) and recurring profits. A company’s operating income is highly crucial for stakeholders.
How to calculate Operating Income?
The formula for operating income can differ based on the available information. As mentioned above, there are several methods that companies can use to calculate this income.
The first involves measuring a company’s operating income from its revenues. The formula for operating income under this method will be as follows.
Operating income = Total revenues – Direct costs – Indirect costs
Similarly, companies may also use the following operating income formula under the same method.
Operating income = Total revenues – Cost of goods sold – Operating expense – Depreciation – Amortization
The second method for calculating operating income involves using gross profits instead of revenues. This process uses the same computation as above. However, it is more compact in operating income calculation. The formula under this method will be as follows.
Operating income = Gross profit – Operating expense – Depreciation – Amortization
Lastly, companies can also calculate their operating income using their net earnings. However, this process takes an opposite approach to the calculation. The operating income formula under this method will be as follows.
Operating income = Net Earnings + Interest + Tax
What is After-Tax Operating Income?
After-tax operating income represents a company’s total operating income after taxes. This figure excludes the after-tax benefits that come from accounting changes.
Therefore, it refers to the operating income after companies account for all taxes or pay them. It is similar to the net operating profit after tax. However, it excludes some items from the calculation.
The calculation for after-tax operating income is similar to operating income itself. However, it also accounts for taxes along with operating expenses and other crucial deductions.
In other words, it is the same as operating income. However, it also includes any tax expenses that relate to the calculation. The traditional operating income becomes the pre-tax income with the after-tax calculation.
However, after-tax operating income is a non-GAAP metric. Therefore, there is no standard way to calculate it. Companies may include or exclude items in this calculation based on different factors.
Therefore, the after-tax operating income may be high or low based on those adjustments. However, it excludes financial expenses, which can differ based on a company’s leverage decisions.
The after-tax operating income measures a company’s operating efficiency. It considers its account expenses that relate directly to ongoing business operations.
However, it excludes nonrecurring items which do not come from those operations. Similarly, it does not include dividends, which is not an accounting expense.
Overall, the after-tax operating income refers to a company’s operating income after tax deductions. This metric does not consider the after-tax benefits arising from accounting changes.
The computation for this metric is similar to operating income. It is close to the net operating profit after tax. However, the calculations may differ slightly.
How to calculate the After-Tax Operating Income?
The formula for after-tax operating income is similar to the operating income formula. As mentioned, however, it also considers the tax calculations. This calculation also differs from the net operating profit after tax calculation. Overall, the after-tax operating income formula is as below.
After-tax operating income = (Gross revenue – Operating expenses – Depreciation) – Taxes
In the above formula, the (Gross revenue – Operating expenses – Depreciation) part is called the pre-tax operating income. It refers to the difference between a company’s operating revenues and its direct expenses.
However, it does not account for taxes. Like the after-tax operating income, the pre-tax operating income measures operating efficiency.
Apart from the above formula for after-tax operating income, there is an alternative method to calculate this figure. This method involves using a company’s effective tax rate or marginal tax rate. Either way, the formula for after-tax operating income under this method will be as follows.
After-tax operating income = Earnings Before Interest and Tax x (1 – Tax) + Depreciation
Example
A company, ABC Co., generated revenues of $5 million while its cost of goods sold was $3 million. Therefore, the company’s gross profits were $2 million.
ABC Co.’s operating expenses for the year were $1 million. Similarly, its depreciation for the year was $0.3 million while its taxes amounted to $0.2 million. Therefore, ABC Co.’s after-tax operating income will be as follows.
After-tax operating income = (Gross revenue – Operating expenses – Depreciation) – Taxes
After-tax operating income = ($3 million – $1 million – $0.3 million) – $0.2 million
After-tax operating income = $0.5 million
Conclusion
Operating income includes a company’s profits after deducting its operating expenses from its gross profits. After-tax operating income is similar to operating income, but it also accounts for taxes.
Usually, this figure can help in measuring a company’s operating efficiency. There are two formulas to calculate after-tax operating income, as mentioned above.