A company’s operating profit is its total earnings from its core business functions for a given period, excluding the deduction of interest and taxes. It also excludes any profits earned from ancillary investments, such as earnings from other businesses that a company has a part interest in.
Operating profit can be calculated using the following formula:
- Operating profit, also called operating income, eliminates a number of extraneous factors that can obscure a company’s real performance.
- It can, however, conceal high extraneous costs such as a large debt load.
- In such cases, net profit is the more relevant number.
Understanding Operating Profit
Operating profit serves as a highly accurate indicator of the business’s health 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.
Given the formulas for gross income (Revenue – COGS), the formula used to calculate operating profit is often simplified as: Gross Profit – Operating Expenses – Depreciation – Amortizations.
Exclusions From the Operating Profit Calculation
Revenue created through the sale of assets is not included in the operating profit figure, with the exception of any items created for the explicit purpose of being sold as part of the core business. In addition, interest earned from cash 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 is the case 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 is tied directly to the core business operations of the second company.
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 its 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 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. If 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 health of a business, it does not in fact guarantee future profitability. Case in point: a company with a high debt load may show a positive operating profit while simultaneously experiencing net losses.
In addition, large but extraneous costs are not represented, which may also show a company with a negative net profit as having a positive operating profit.