Operating Profit



Next video:
Loading the player...

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.

Related Articles
  1. Term

    Gross, Operating and Net Profit Margins

    A company’s income statement includes the company’s gross, operating and net profits.
  2. Fundamental Analysis

    Analyzing Operating Margins

    Find out how to put this important component of equity analysis to work for you.
  3. Investing Basics

    Operating Income

    Amount of profit realized from a business's operations after taking out operating expenses - such as cost of goods sold (COGS) or wages - and depreciation.
  4. Investing

    What are Operating Expenses?

    An operating expense is any expenditure made for the purpose of operating a business. These expenses are the day-to-day costs that help keep the business going. Operating expenses are reflected ...
  5. Investing Basics

    Profit Metrics: Gross, Operating & Net Profits

    In addition to net profit, most analysts look at a company’s gross profit and operating profit to gauge performance.
  6. Economics

    Is Net Income The Same As Profit?

    Net income and profit both deal with positive cash flow, but there are important differences between the two concepts.
  7. Economics

    Understanding Product Lines

    A product line is a group of related products manufactured by the same company.
  8. Economics

    What Is The Difference Between Revenue And Profit?

    Think of revenue as the top line of a company’s income statement. Profit is the infamous bottom line.
  9. Economics

    Calculating Operating Ratio

    An operating ratio compares a company’s operating expenses to its net sales.
  10. Economics

    What is Operating Revenue?

    Operating revenue is income that’s derived from sources related to a company’s everyday business operations.
Hot Definitions
  1. Labor Market

    The labor market refers to the supply and demand for labor, in which employees provide the supply and employers the demand. ...
  2. Demand Curve

    The demand curve is a graphical representation of the relationship between the price of a good or service and the quantity ...
  3. Goldilocks Economy

    An economy that is not so hot that it causes inflation, and not so cold that it causes a recession. This term is used to ...
  4. White Squire

    Very similar to a "white knight", but instead of purchasing a majority interest, the squire purchases a lesser interest in ...
  5. MACD Technical Indicator

    Moving Average Convergence Divergence (or MACD) is a trend-following momentum indicator that shows the relationship between ...
  6. Over-The-Counter - OTC

    Over-The-Counter (or OTC) is a security traded in some context other than on a formal exchange such as the NYSE, TSX, AMEX, ...
Trading Center