What Is Operating Income?
Operating income is an accounting figure that measures the amount of profit realized from a business's operations, after deducting operating expenses such as wages, depreciation, and cost of goods sold (COGS).
Operating income takes a company's gross income, which is equivalent to total revenue minus COGS, and subtracts all operating expenses. A business's operating expenses are costs incurred from normal operating activities and include items such as office supplies and utilities.
What Does Operating Income Tell You?
Operating income is a measurement that shows how much of a company's revenue will eventually become profits. Operating income is similar to a company's earnings before interest and taxes (EBIT) and is also referred to as the operating profit or recurring profit. The one big difference between operating income and EBIT is that EBIT includes any non-operating income the company generates.
Operating income is calculated as:
Operating Income=Gross Income−Operating Expenses
Operating expenses include selling, general, and 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. In addition, nonrecurring items such as cash paid for a lawsuit settlement are not included. Operating income is required to calculate the operating margin, which describes a company's operating efficiency.
Operating Income Example
Many companies focus on operating income when measuring the operational success of the business. For example, Company ABC, a hospital and drug firm, reports an operating income rise by 20% year-over-year to $25 million during the first two quarters of its fiscal year. The company realized an increase in revenue and operating income due to an increase in patient volume over the two quarters. The rise in patient visits was driven by two of the company's new immunotherapy drugs: One treats lung cancer, and the other treats melanoma.
In another example, we have Company Red, which reports financial results for the first quarter of its fiscal year. The company saw operating income rise by 37% when compared with the same period in the previous year. The report of the increase in operating income is especially important because the company is looking to merge with Company Blue, and shareholders are slated to vote on the potential merger next month. While Company Red's first quarter sales did fall by 3%, its operating income growth could potentially give Company Blue shareholders confidence in voting to merge the two companies.