Profit is vital for monitoring a company’s performance as it represents positive net cash flow to the business.
In business, profits, earnings and incomes are used interchangeably. It’s the amount that is left over after accounting all the expenses against revenue. We have different types of profits calculated based on how expenses are incurred by the company. One of such measures is operating profit.
Operating profit is what is left over when you deduct a company’s operating costs, the cost of goods sold and other day to day expenses from total revenue. It’s the total earnings from a company’s primary or core business.
How to calculate Operating Profit – Formula
Here is the basic formula to calculate operating profit of an organisation;
Operating income / profit = Revenue – cost of goods sold – operating costs – depreciation and amortisation
If the result is negative, then it’s referred to as operating loss.
Revenue is the money that a company has earned by selling goods and services to its customers. Revenue is referred to as the top line of a company, as it’s the first line that appears in an income statement.
Cost of goods sold refers to the total direct cost that the company has incurred to produce its products or services.
Operating profit not only factors in an organisation’s direct costs, but indirect costs, too. Therefore operating profit is what is left of revenue after deducting overhead costs.
While calculating operating profit you should exclude interest, taxes and any profit earned from ancillary investments. Due to this reason, operating profit is also referred to as Earnings before interest and taxes (EBIT), as interest and taxes are considered as non-operating expenses of a company.
However, in the EBIT calculation we consider non-operating revenues, which is not included in calculation of operating income or profit.
Example to show you how operating profit is calculated
Suppose during the year XYZ limited has a total revenue of Rs 100 crore, with costs as follows;
- Cost of goods sold: Rs 50 Lakhs
- Operating Costs: Rs 30 Lakhs
- Depreciation: Rs 50 thousand
- Company’s operating profit = Rs 100 crores – Rs 50 Lakhs – Rs 30 Lakhs – 50 thousand = 19.5 lakhs
Similar to net profit margin, you can calculate operating profit margin by dividing operating income by revenue.
Here is a format to show you how operating income / profit is calculated;
| Particulars | Amount in Rs |
|---|---|
| Revenue | 100 Crores |
| Cost of goods sold (COGS) | 50 Lakhs |
| Gross Profit (Revenue – COGS) | 50 Lakhs |
| Operating Costs | 30 Lakhs |
| Depreciation | 50 thousands |
| Operating income or profit (Gross Profit – Operating Costs – Depreciation) | 19.50 Lakhs |
What operating profit can tell you?
Operating profit of a company can easily tell you whether the company is profitable from its core business to take care of finance costs. It considered those factors that are necessary to keep the business running.
If a company has high debt, then operating income is calculated to know its financial situation. A high debt company may show you positive operating profit, even though its in net loss after taking out finance costs.
Some investors use operating profit to measure operating performance. Others use the “bottom-line” net income.
