Many of the terms used in finance and accounting may seem almost interchangeable to the average person. However, several of these seemingly identical terms actually have very specific meanings and contextual uses.
Both concepts begin with a company's revenue. Simply put, revenue is the total amount of income from the sale of products or services associated with the company's main business function. For a grocery store, this includes the sale of everything from produce to dog food. Revenue is found at the very top of an income statement and all further calculations begin with this figure.
What Is Operating Profit?
Operating profit is the amount of revenue that remains after accounting for variable expenses and fixed operating expenses. This includes expenses for the raw materials used to create products for sale, called cost of goods sold or COGS, and all the day-to-day costs of running a business, such as rent, utilities, payroll and depreciation.
Operating Profit = Operating Revenue - COGS - Operating Expenses - Depreciation and Amortization
Also referred to as earnings before interest and tax (EBIT), operating profit represents the earning power of the company with regard to revenues generated from ongoing operations.
A company's operating profit margin must be healthy to remain financially solvent and grow. Ultimately, the operating profit margin shows how effective a company is at managing its costs, so it provides an evaluation of the strength of a company's management. The margin is best evaluated over time and compared to those of competing firms. A higher operating profit margin means that the company is managing its costs well and earning more in revenue per dollar of sales.
What Is Net Income?
Revenue is the top line of the income statement and net income is the renowned bottom line. Net income, also called net profit, reflects the amount of cash that remains after accounting for all expenses and income.
Businesses use net income to calculate their earnings per share (EPS). Publicly traded companies release reports on their net income on a quarterly and annual basis. If a company can steadily increase its net profit margin over time, its share price is likely to increase as well due to the continuing increase in the company's profits.
Differences Between Operating Profit and Net Income
Expenses that factor into the calculation of net income but not operating profit include payments on debts, interest on loans and one-time payments for unusual events such as lawsuits. Additional income not counted as revenue is also considered in the calculation of net income and includes interest earned on investments and funds from the sale of assets not associated with primary operations.
While both are measurements of profitability, operating profit is just one of many calculations that occur on the way from raw revenue to net income.