Operating income and net income both show the income earned by a company, but the two represent distinctly different ways of expressing a company's earnings. Both metrics have their merits, but also have different deductions and credits involved in their calculations. It's in the analysis of the two numbers that investors can determine where in the process a company began earning a profit or suffering a loss.
Operating income is a company's profit after deducting operating expenses which are the costs of running the day-to-day operations. Operating income, which is synonymous with operating profit, allows analysts and investors to drill down to see a company's operating performance by stripping out interest and taxes.
Operating expenses include selling, general & administrative expense (SG&A), depreciation and amortization, and other operating expenses. Operating income excludes items such as investments in other firms (non-operating income), taxes, and interest expenses. Also, nonrecurring items such as cash paid for a lawsuit settlement are not included.
Operating income is also calculated by subtracting operating expenses from gross profit. Gross profit is total revenue minus COGS.
Net Income is a company's profits or earnings. Net income is referred to as the bottom line since it sits at the bottom of the income statement and is the income remaining after factoring in all expenses, debts, additional income streams, and operating costs. The bottom line is also referred to as net income on the income statement.
- Net income is calculated by netting out items from operating income that include depreciation, interest, taxes, and other expenses.
- Sometimes, additional income streams add to earnings like interest on investments or proceeds from the sale of assets.
- In short, net income is the profit after all expenses have been deducted from revenues. Expenses can include interest on loans, general and administrative costs, income taxes, and operating expenses such as rent, utilities, and payroll.
Example: Operating Income and Net Income
J.C. Penney Company Inc. (JCP)
Below is the 2017 income statement for J.C. Penney as reported on their 10K annual statement. The highlighted areas include operating income and net income to demonstrate how the figures are calculated.
- Revenue or total net sales = $12.5 billion. Net sales refers to revenue minus returned merchandise, which is common for retailers.
- Operating Income = $116 million and included all the expenses associated with operating for the year including rent, utilities, and payroll.
- Net income = -$116 million, which was a loss for the year, and is highlighted in pink at the bottom of the statement.
The Bottom Line
You'll notice that J.C. Penney earned $116 million in operating income while earning $12.5 billion in total revenue or net sales. However, after deducting the interest paid on their debt which totaled $325 million, the company's operating income was wiped out. As as a result, net income was a loss of $116 million for the year.
Operating income and net income both show income for a company. However, it's important to analyze all areas of their financial statements to determine where a company is making money or losing money as in the case of J.C. Penney for 2017.
For more on this topic, please read "What Is the Difference Between Revenue And Profit?"