Operating Profit

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Operating profit, also known as operating income, is a measure of a company’s efficiency. It is the profit generated from the core business of a company before accounting for interest and taxes. In accounting terminology, operating profit is known as earnings before interest and taxes (EBIT).

The operating profit for a business like Giacomo's Pizza is going to be the pre-tax profit generated from selling pizzas - which is the core business of the company. Remember, earnings not directly related to the core business operations are not included when calculating operating profit. The earnings that will be left out of the calculation are: income from the company's investments, capital gains on asset sales, rental income, bank account interest, miscellaneous earnings like fees, dividends, and so on.   

Operating profit is calculated as:

Operating Profit = Operating Revenue – Cost of Goods Sold (COGS) – Operating Expenses – Depreciation

Here, operating revenue is the income from the company’s core business operations. COGS, or cost of goods sold, is the cost incurred in manufacturing and selling the company’s products. Operating expenses include expenses related to sales, marketing, R&D, administration, restructuring, etc. Depreciation accounts for the decrease in the value of the assets over time.

Consider the income statement of Giacomo's Pizza.

Giacomo’s Pizza Ltd

Revenue

$2,000,000

Interest earned in bank accounts

$80,000

Earning from 30% stake in Yes Beverages Ltd.

$1,000,000

Cost of Goods Sold (COGS)

$1,000,000

Labor

$400,000

General & administrative expenses

$50,000

 

Based on the information, the operating profit for Giacomo’s Pizza will be,

Operating Profit = $2,000,000 - $1,000,000 - $400,000 - $50,000 = $550,000

The sum of $80,000 and $1,000,000 is not included because it is income from investments, not from selling pizzas. 

Operating profit helps gauge the health of a company's core business and is one of the important factors to consider when an investor is looking to pick the company’s stock. Using this measure for comparison makes the most sense when comparing companies within the same industry. If a company is experiencing a decline in its operating profit, this reflects that there is less money for future expansion, paying off debt burden, etc. Operating profit shows the profits from a company’s core business that are not diluted with income from any other source, and thus reveals a lot about the profit-generating capacity of the management.

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