Operating Income
Operating income is the residual amount of revenue left after deduction of the cost of goods sold (COGS) and operating expenses. It is one of the measures of the profitability of the operations of an organization.
It infers investors and owners about the amount of revenue that would eventually turn out to profit for the company.
It is one of the primary indirect indicators of the measure of the efficiency of an entity. Higher the operating income, higher is the operating efficiency and profitability from the core operations.
Operating income can be calculated by the formula:
Operating income = Total Revenue – Direct Costs – Indirect Costs
Or
Operating income = Gross Profit – Operating Expenses – Depreciation – Amortization
Earnings before interest and tax (EBIT)
EBIT refers to Earnings Before Interest and Tax. It is calculated by subtracting the cost of goods sold and its operating expenses from sales revenue. EBIT is the sum of net income, interest, and taxes. It is a measure of the profitability of the company.
It indicates the earning potential of the company. It enables us to calculate revenue minus expenses (including interest and tax). EBIT is calculated by the following formula:
EBIT= Net Income + Interest + Taxes
Or,
EBIT = EBITDA – Depreciation and Amortization Expense
The differences between Operating income and EBIT are as follows:
| Basis of difference | Operating Income | EBIT |
| Definition | It reflects the profits earned by company operations | It is used to calculate the company’s profitability |
| Usage | It is used to gauge the profit-making capacity of the company. | It is used to know how much revenue can be converted to profits. |
| GAAP | Operating income is the official financial measure by GAAP | EBIT is not recognized by GAAP as an official financial measure |
| Gain or loss from fixed asset sale | Gain or loss from a fixed asset sale is not included in operating income. | EBIT covers gain or loss from sales of fixed assets. |
| Non-operating expenses | Non-operating expenses are excluded in calculating operating income. | Non-operating expenses are included in calculating operating income. |
| Non-operating income | Non-operating income is excluded in calculating operating income. | Non-operating income is included in calculating operating income. |
| Profits | It calculates operating profits only. | It calculates profits from other sources too besides operating profit. |
| Adjustments | No adjustments are required in its calculations. | Adjustments are made under its calculation. |
| Operating expenses | It includes operating incomes and expenses only in its calculation. | Any other non-operating incomes or expenses are also taken into account |
| Basis of calculation | It is calculated based on gross income. | It is calculated based on net income. |
| Consideration | Interest and tax expenses are not taken into account. | Interest and tax expenses are added to net income to get EBIT |
| Calculation | Gross Income- Operating Expenses | Net Income+ Interest + taxes |
| Position in the income statement | It is presented above EBIT in the income statement. | It is presented below operating income in the income statement. |
| Performance metric | Performance of business operations can be gauged from operating income vis-à-vis the previous year or figure of other firms. | Performance of business operations can’t be gauged from operating income vis-à-vis previous year or figure of other firms |
The differences between operating income and EBIT can be gauged from the following income statement.
Income statement for the year ended 31st Dec, 2020
| Revenue | 15,00,000 |
| Direct costs | 5,00,000 |
| Gross Profit | 10,00,000 |
| Operating expenses | |
| Salaries | 150000 |
| Repairs | 50000 2,00,000 |
| Operating Profit | 8,00,000 |
| Interest income | 50,000 |
| EBITDA | 750,000 |
| Depreciation | 50,000 |
| EBIT | 700,000 |
From the above income statement, we can easily gauge the difference between operating income and EBIT. In the above statement, we can conclude the following:
- Operating income is presented above the EBIT.
- Operating income includes depreciation while EBIT excludes depreciation.
- Operating income is always higher than EBIT unless otherwise.
- Operating income includes operating expenses, EBIT includes operating and non-operating expenses.