Operating Income

Operating income is the residual amount of revenue left after deduction of the cost of goods sold (COGS) and operating expenses from the revenue or net sales during the specific period or during the year. It is one of the measures of the profitability of the operations of an organization.

The increase or decrease of operating income is really depending on revenue or net sales and the cost of goods sold. Operating income increase will result in an increase in gross profit margin.

It infers investors and owners about the amount of revenue that would eventually turn out to be profits 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                

Or

Operating income = Net Earnings + Interest Expense + Taxes

Net income

Net Income is the profit remaining after all costs incurred during the period have been subtracted from sales revenue. It is important since it helps to calculate Earnings Per Share (EPS). It is the last line of the income statement and often referred to as the “Bottom line number”.

It includes every type of income and expenses. If a company is able to steadily increase the net income of a company over a period of time, its share price will eventually rise.  

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Net income = Operating Income – Expenses – Taxes

The differences between Operating Income and Net Income are discussed below:

BasisOperating IncomeNet Income
DefinitionIt signifies the income from the principal revenue-generating activities of the company.It is the income generated from all the operations of the company.
SignificanceIt calculates how much revenue converts into profit.It depicts the earning potential capacity of the company.
FormulaGross income- Operating expense- Depreciation and amortizationOperating income + Other Income-Interest expense + Extraordinary income- Extraordinary Expense-Taxes
TaxesTaxes are not considered to calculate income.Taxes are deducted to calculate income.
UsesUsed to calculate ROCE (Return on Capital Employed)Used to calculate EPS, ROA or ROE
EvaluationIt gives evaluation of operational performance of company.It simply offers earnings evaluation rather than performance evaluation.
PositionIt sits much above the net income in the income statement.It sits at the bottom of the income statement.
IncomeIt doesn’t include profit/loss from investment or sale of capital goods.It includes profits/loss from investment or sale of capital goods.
TransferIt is not transferred to capital Account of shareholders.It is transferred to capital account of shareholders.
PresentationIt is presented in income statement only.It is presented in income statement and balance sheet
Non-operating incomeIt doesn’t include non-operating income.It includes non-operating income.
Non-operating expensesIt doesn’t include non-operating expenses.It includes non-operating expenses.
Other namesIt is also called Earnings Before Income and TaxIt is also called Earning After Tax
Taxation purposeThis income is not used in calculating taxable income.This income is used to calculate total taxable income.
PurposeIt is used to understand and eliminate the unnecessary operating expenses.It is useful in knowing the financial performance of the entity.
Ratio usedThe operating profit ratio is used to gauge operating profit vis-à-vis sales.Net profit ratio is used to gauge operating profit vis-à-vis sales.
Share priceIt doesn’t affect share price.Increase in net profits increase the share price.
Use to investorsInvestors are not interested in knowing the operating profit.A huge net profit results in distribution of higher dividends to shareholders.
Leverage effectOperating profit doesn’t consider leverage effect.Net profit considers leverage effect as interest expenses are deducted.
ValuationOperating profits are not considered for valuation purpose.Net profit is the profit considered for valuation of a company.
DividendDividend is not distributed on the basis of this income.Dividend is distributed as a percentage of net income.
ImportanceThis income is useful for the operations management team.This is useful for shareholders of a company.