What is Operating Profit
The term “operating profit” refers to an accounting metric measuring the profits a company generates from its core business functions, where the deduction of interest and taxes is excluded from the calculation. This operating value likewise excludes any profits earned from the firm's ancillary investments, such as earnings from other businesses a company may be partially vested in.
Operating profit can be calculated using the following formula:
BREAKING DOWN Operating Profit
Operating profit serves as a highly accurate indicator of the business’s potential profitability because it removes all extraneous factors from the calculation. All expenses that are necessary to keep the business running are included, which is why operating profit does take into account asset-related depreciation and amortization, which are accounting tools that result from a firm's operations. Operating profit is therefore distinct from net income, which can vary from year to year, due to these exceptions in a firm's operating profit.
Operating profit is also referred to as operating income, as well as earnings before interest and tax (EBIT) — although the latter may sometimes include non-operating revenue, which is not a part of operating profit. If a firm does not have non-operating revenue, its operating profit will equal EBIT.
Exclusions From the Operating Profit Calculation
Revenue created through the sale of assets, outside any items created for the explicit purpose of being sold as part of the core business, are not included in the operating profit figure. Additionally, interest earned through mechanisms such as checking or money market accounts is not included.
While the removal of production costs from overall operating revenue, along with any costs associated with depreciation and amortization, are permitted when determining the operating profit, the calculation does not account for any debt obligations that must be met. This holds true, even if those obligations are directly tied to the company’s ability to maintain normal business operations.
Operating income does not include investment income generated through a partial stake in another company, even if the investment income in question is tied directly to the core business operations of the second company. Additionally, the sale of assets such as real estate and production equipment is not included, as these sales are not a part of the core operations of the business.
An Example of Operating Profit
Walmart Inc. reported operating income of $20.4 billion for its fiscal year 2018. Total revenues, which were equal to total operating revenues, tallied $500.3 billion. These revenues came from sales across Walmart's global umbrella of physical stores, including Sam's Club, and e-commerce businesses. Meanwhile, the cost of sales (or COGS) and operating, selling, general and administrative expenses, totaled $373.4 billion and $106.5 billion, respectively. The firm did not separately list amortization and depreciation on its income statement.
- OR [$500.3 billion] - COGS [$373.4 billion] - OE [$106.5 billion] = Operating Profit [$20.4 billion]
From the $20.4 billion, net income further subtracted interest expenses of $2.2 billion, a loss on extinguishment of debt totaling $3.1 billion and a provision for income taxes of $4.6 billion, for a net income total of $10.5 billion.
Benefits and Drawbacks of Referring to the Operating Profit Figure
Companies may choose to present their operating profit figures in lieu of their net profit figures, as the net profit of a company contains the effects of interest payments and taxes. In cases where a company has a particularly high debt load, the operating profit may present the company’s financial situation more positively than the net profit reflects.
While positive operating profit may express the overall profit potential of a business, it does not in fact guarantee profitability. Case in point: a company with a high debt load may show a positive operating profit, while simultaneously experiencing net losses. Additionally, large but extraneous costs are not represented, which can likewise show a company with a negative net profit as having a positive operating profit.