Operating income and revenue are important metrics that both show the money made by a company. However, the two numbers are different ways of expressing a company's earnings, and they have different deductions and credits involved in their calculations, Nevertheless, both revenue and operating income are essential in analyzing whether a company is performing well.
- Revenue is the total amount of income generated by a company for the sale of its goods or services before any expenses are deducted.
- Operating income is the sum total of a company's profit after subtracting its regular, recurring costs and expenses.
- The disparity between these two figures can be an important barometer of a company's financial health.
What Is Revenue?
Revenue is the total amount of income generated by a company for the sale of its goods or services. It refers to the sum generated before any expenses—such as those involved in running the business—are taken out. Revenue is often called the "top line" because it's located at the top of the income statement. So, when a company is said to have "top-line growth," it means the company's revenue—the money it's taking in—is growing.
Revenue is also often referred to as net sales. Technically, net sales refer to revenue minus any returns of purchased merchandise.
Revenue or net sales refer only to business-related income (the equivalent of earned income for an individual). If the company has other sources of income from investments, for example, the income is not considered revenue since it wasn't the result of the primary business. Any additional income is accounted for separately on balance sheets and financial statements.
What Is Operating Income?
Revenue, as we said, refers to earnings before the subtraction of any costs or expenses. In contrast, operating income is a company's profit after subtracting operating expenses, which are the costs of running the daily business. Operating income helps investors separate out the earnings for the company's operating performance by excluding interest and taxes.
Operating expenses include selling, general & administrative expense (SG&A), depreciation, and amortization. Operating income does not include money earned from investments in other companies or non-operating income, taxes, and interest expenses. Also excluded: any special or nonrecurring items, such as cash paid for a lawsuit settlement.
Operating income can also be calculated by deducting operating expenses from gross profit; gross gross profit is total revenue minus cost of goods sold (COGS_.
Real-Life Example of Revenue and Operating Income
A company's revenue and its operating income can end up as two dramatically disparate numbers.
Below is an example where operating income and revenue are highlighted to illustrate the differences between the two figures. The income statement is for J.C. Penney as of the end of 2017 as reported on its 10K annual statement. Note that:
- The company's total revenue or total net sales was the same. Net sales amount to revenue minus returned merchandise, which is common for retailers.
- Operating Income is located further down the statement after deducting the expenses associated with operating for the year. The expenses included the cost of goods sold of $8.1 billion and SG&A, or costs not directly tied to production, of $3.4 billion for a total of $12.39 billion (highlighted in red) to come up with the $116 million in operating income.
To sum up: J.C. Penney earned $116 million in operating income while earning $12.5 billion in total revenue. Alone, the $12.5 billion in revenue appears impressive at the onset, but when factoring in expenses, the operating income was only $116 million. Also, you'll notice that net income—the actual profit of the company, also known as the bottom line—is actually a negative $116 million.
In other words, J.C, Penney posted a loss for the year of $116 million after deducting the interest paid on its outstanding debt. It was paying that debt that put it in the red. Even so, the disparity between the revenue number and the operating income number is striking.
The Bottom Line
The difference between these two figures shows why analyzing financial statements can be challenging. That's why you need to consider multiple metrics in calculating the profitability of a company before investing. If you just considered Penney's revenue, it would seem it could carry its $325 million in interest payments with no problem. But when you see how small its operating income is, you realize this company could easily sink under the weight of its service obligations—something to consider before purchasing its stock.