Operating profit is the net income derived from a company’s core operations. Put another way, it is the amount of money that a company has left over after meeting its operating costs (gross profit) but before paying its taxes. But why is this such an important facet of a company’s finances?
Making money is important. But generating revenue is not the only measure of a company’s financial health. It also needs to keep track of its margin. Operating profit margin is an important margin to track and a very useful financial KPI. Everything used to calculate a company’s operating profit is relevant to the company’s financial health. It takes into account only expenses that are essential in maintaining ordinary operations. It also includes costs that result from everyday operations such as depreciation and amortisation.
Operating profit excludes non-operating income such as:
sales of assets
gains from foreign exchange transactions
investment gains and dividends
It also excludes non-operating expenses such as:
interest payments on debts
costs associated with mergers, acquisitions or restructuring
Because it only factors in costs and revenues from the company’s core operations, it is a more reliable indicator of operational profitability than similar KPIs, like earnings before interest and taxes (EBIT).
Example of operating profit
Company X is a national blended retailer making £300,000 this year in sales revenue. This comes from selling goods within the UK and to customers overseas. However, it also earns other non-operating income such as foreign exchange gains to countries where the exchange rate is favourable. This year, it also refitted several of its stores, offsetting the costs by selling on its old fixtures and fittings.
The [cost of goods sold (COGS) are factored into operating profit. This includes all costs directly associated with bringing the products to market including:
Other operational costs such as sales and marketing costs are also included in operational costs, as are costs associated with shipping, warehousing and logistics. Overall, these total £180,000 across all of the company’s sites. In line with HMRC guidelines, the company was also able to claim £15,000 in asset depreciation.
However, the costs associated with the shopfitting are not included, nor is the revenue generated from selling the old fittings and from favourable foreign exchanges.
So the company’s operating profit for the year is £105,000.
Operating profit formula
Operating profits are calculated by starting out with your company’s revenue for a given period. Then subtract your COGS, as well as other operating expenses such as sales and marketing costs and any other expenses associated with core operations. Next, deduct costs associated with depreciation and amortisation.
The resulting figure will give you your company’s operating profit for the period.
Frequently asked questions about operating profit
Why is operating profit important?
Along with gross profit and net profit, operating profit is an important margin to track. It provides a reliable indicator of how healthy your company is and how profitable its day-to-day operations are. This is because it exclusively factors in revenues and expenses that are integral to ordinary business operations.
Is operating profit the same as EBIT?
Yes and no. Operating income expresses a company’s earnings before interest and taxes (EBIT), so in this respect, they are the same. While they are often used interchangeably, there is a subtle distinction in the definitions. The income component makes all the difference between the two. EBIT includes non-operational income such as income from investments or the sale of assets. Operating profit, however, does not. It only factors in operational expenses, making it a more reliable indicator of how profitable core operations are than EBIT.