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What Is Operating Profit?
Operating profit is a measure of the profit earned from a company’s ongoing core business operations, excluding deductions of interest and taxes.
- Operating profit represents what remains after you deduct direct and indirect costs from sales revenue.
- Operating profit differs from gross profit (sometimes called gross income or gross earnings) and net profit (net income or net earnings). But the operating profit margin is related and can be calculated from them.
What Is the Difference Between Operating Profit and EBIT?
Operating profit is sometimes called Earnings Before Interest and Taxes, or EBIT.
But that’s only true for a company that doesn’t have revenues from sources outside its core business of making and selling a good or service. Non-operational revenue includes such things as dividend income, capital gains from investments, gains from foreign exchange, and asset write-downs.
Operating Profit Formula
The formula for calculating operating profit is as follows:
Revenues – Direct Costs – Indirect Costs = Operating Profit
Another way to express this:
Revenues – Operating Costs = Operating Profit
Here are a few examples of how to calculate operating profit from an income statement.
Company A's income statement reveals the following:
Revenues: $2.3 billion
- Cost of goods sold: $982.7 million
- Operating expenses: $115.7 million
- Depreciation and amortization: $42 million
Company A's operating income is calculated thusly:
$2,300,000,000 – $982,700, 000 – $115,700,000 – $42,000,000 = $1,159,600,000
Company A's operating profit is $1.16 billion. That's before interest earned from investments and any taxes are paid to the government.
Here’s another example. Company B's income statement shows the following:
Total revenue: $1 million
- Cost of goods sold: $500,000
- Operating expenses: $300,000
- Depreciation and amortization: $150,000
Company B's operating profit is calculated thusly:
$1,000,000 - $500,000 - $300,000 - $50,000 = $150,000
Operating Profit vs. Gross Profit vs. Net Profit
Operating profit differs from gross profit and net profit. But it can be derived from them and vice versa. Here are three formulas that demonstrate the relationship among the three measures of profitability:
- Operating Profit = Gross Profit – Operating Expenses – Depreciation – Amortization
- Operating Profit = Net Profit + Interest Expenses + Taxes
Depending on the degree of non-operational factors, operating profit may differ significantly from net profit, especially during periods of economic upheaval, industry disruption, changes in corporate or managerial structure, or the existence of large debt loads.
It's possible for a company's operating profit to exceed its net profit (or even net loss). A company may choose to emphasize its operating profit over its net income; a canny investor or competitor will pay attention to both in context.
Why Do You Need to Understand Your Operating Profit?
Knowing your operating profit means you understand your cash flow for everything else: salaries, rent, travel, raw materials, and energy.
It shows you how much money you’re making before you have to pay for things that are beyond your control, such as interest payments and taxes.
- Operating profit lets you see how well you are controlling costs. Comparisons year over year provide trends for pricing strategy, labor costs, and raw material prices.
- Operating profit also gives investors a quick snapshot of a company's day-to-day management and the choices they make. Over time, operating profit creates a trend line that offers a glimpse at management's flexibility and responsiveness to change, as well as a potential trajectory for a company's prospects.
- Comparing the operating profit of companies in a particular industry can help an investor assess whether a company is performing better or worse than its competitors and, all things being equal, how its management measures up as a consequence.
Operating profit is useful to generate another key measure of a company's profitability: Its operating margin.
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