Formula to Calculate Operating Income

Mathematically, operating income can be calculated using two methods

Method 1

Operating Income Formula = Total Revenue – Cost of Goods Sold – Operating Expenses.

Method 2

Alternatively, the Formula for operating income can also be calculated by adding back interest expense and taxes to the net income (adjusted for non-operating incomeNon-operating IncomeNon-recurring items are income statement entries that are unusual and unexpected during regular business operations; examples include profits or losses from sale of asset, impairment costs, restructuring costs, and losses in lawsuits, and inventory write-off.read more and expense), which is mathematically represented as,

Operating Income = Net Income + Interest Expense + Taxes

You are free to use this image on you website, templates, etc., Please provide us with an attribution linkHow to Provide Attribution?Article Link to be HyperlinkedFor eg:Source: Operating Income Formula (wallstreetmojo.com)

Steps to Calculate Operating Income

On the other hand, the following four steps help in the calculation of the Operating Income by using the alternate method:

  • Firstly, the total revenue has to be noted from the profit and loss account. For example, the total revenue will be computed in a manufacturing company by multiplying the number of units produced with the average price per unit. Total Revenue = Number of Units Produced * Average Price Per Unit The cost of goods sold is also available in the profit and loss account. It is calculated by adding the raw material purchase during the accounting period to the beginning inventory and then deducting the closing inventory. Cost of Goods Sold = Beginning inventory + Purchase of raw material – Closing inventory The operating expenses are also gathered from the profit and loss accounts. It includes various direct and indirect costs like labor, depreciation, administrative expenses, etc. Finally, the EBIT is arrived at by deducting the values derived in Step 2 and Step 3 from the value in Step 1, as shown below. EBIT = Total revenue – Cost of goods sold – Operating expenses

Total Revenue = Number of Units Produced * Average Price Per Unit

Cost of Goods Sold = Beginning inventory + Purchase of raw material – Closing inventory

EBIT = Total revenue – Cost of goods sold – Operating expenses

Step 1: Firstly, the net income must be captured, which is easily available in the profit and loss account as a line item. Ensure that non-operating income (deducted) and expense (added back) have been adjusted as these are not part of the core operation.

Step 2: The interest expenseInterest ExpenseInterest expense is the amount of interest payable on any borrowings, such as loans, bonds, or other lines of credit, and the costs associated with it are shown on the income statement as interest expense.read more is also available in the profit and loss account. It is the product of the effective rate of interest and outstanding borrowing across the year.

Step 3: The taxes are also collected from the profit and loss accountProfit And Loss AccountThe Profit & Loss account, also known as the Income statement, is a financial statement that summarizes an organization’s revenue and costs incurred during the financial period and is indicative of the company’s financial performance by showing whether the company made a profit or incurred losses during that period.read more.

Step 4: Finally, the EBIT is derived by adding back the values derived in Step 2 and Step 3 to the value in Step 1, as shown below.

EBITEBITEarnings before interest and tax (EBIT) refers to the company’s operating profit that is acquired after deducting all the expenses except the interest and tax expenses from the revenue. It denotes the organization’s profit from business operations while excluding all taxes and costs of capital.read more = Net income + Interest expense + Taxes

Calculation Examples of Operating Income

Let’s see some simple to advanced examples of EBIT to understand it better.

Example #1

Let us consider an example to calculate EBIT for a company called ABC Limited, which manufactures customized roller skates for both professional and amateur skaters. At the end of the financial year, the company had generated $150,000 in total revenue and the following expenses.

In the below-given Screenshot is the data used for the Calculation of Operating Income

We will use the following values for the calculation of Operating Income.

Cost of Goods Sold

Net Income

Therefore, Net income = $41,000

At the end of the financial year, ABC Limited’s net income stood at $41,000.

Now, Using the first method to calculate Operating Income is as follows –

i.e. EBIT = $150,000 – $70,000 – $25,000

EBIT will be –

So, EBIT = $55,000

Now, we will calculate Operating Income using the second method mentioned above.

i.e. EBIT = $41,000 + $10,000 + $4,000

Example #2 (Apple Inc)

Let us take the real-life example of Apple Inc.’s annual reportAnnual ReportAn annual report is a document that a corporation publishes for its internal and external stakeholders to describe the company’s performance, financial information, and disclosures related to its operations. Over time, these reports have become legal and regulatory requirements.read more on September 29, 2018. The following information is available:

The calculation of Operating Income will be as follows –

Therefore,

  • EBIT (in Millions) = Net income + Interest expense + Tax – Non-Oper. IncomeEBIT = $59,531 + $3,240 + $13,372

Operating Income will be –

  • EBIT = $70,898

Operating Income Calculator

You can use the following EBIT Calculator.

Relevance and Use

EBIT is a profitability metric that helps assess how a company is performing, which is calculated by measuring profit before payment of interest to lenders or creditors and taxes to the government. It is a profitability calculation measured in terms of dollars and not in percentages like most other financial terms.

However, the operating income formula remains a limitation that is particularly useful when comparing similar companies in the same industry. Since the EBIT formula only measures profit in terms of dollar amount, investors and other financial users usually find it difficult to use this metric to compare differently sized (small & medium enterprise, mid-corporate, and large corporate) companies across the industry.

Calculate Operating Income in Excel (with template)

Now let us take the Apple Inc.’s published financial statement example for the last three accounting periods. Based on publicly available financial informationFinancial InformationFinancial Information refers to the summarized data of monetary transactions that is helpful to investors in understanding company’s profitability, their assets, and growth prospects. Financial Data about individuals like past Months Bank Statement, Tax return receipts helps banks to understand customer’s credit quality, repayment capacity etc.read more the EBIT (in dollar terms) of Apple Inc. can be calculated for the accounting years 2016 to 2018.

In the below-given table is the data for the calculation of EBIT using both the formula mentioned above.

Calculation of Operating Income using the first formula.

So EBIT for Sep 29, 2018, will be –

Similarly, we will calculate the EBIT for  Sep 30, 2017, and  Sep 24, 2016

Calculation of Operating Income using the Second formula.

So the Income for Sep 29, 2018, will be –

From the above table, we can see that the EBIT of Apple Inc. in dollar terms has been growing during the period, which is a positive sign for the company.

This has been a guide to Operating Income Formula. Here we discuss how to calculate Operating Income using practical examples and downloadable excel templates. You may learn more about Financial Analysis from the following articles –

  • Calculate Operating Cash FlowCalculate Operating Cash FlowThe operating cash flow formula depicts the operational cash flow acquired after deducting the operating expenses from the total revenue. It can also be evaluated as the aggregate of net income, changes in assets and liabilities and non-cash expenses.read moreLTM EBITDALTM EBITDALTM EBITDA (Last Twelve Months EBITDA) calculates the company’s earnings before taxes, interest, and amortization & depreciation of components for the past twelve consecutive months. It determines operating cash flow, helps in the valuation of a business.read moreEBIT vs Net IncomeEBIT Vs Net IncomeEBIT refers to the business’s earnings earned during the period without considering the interest expense and the tax expense of that period. In contrast, net income relates to business profits earned during the period after considering all the expenses incurred by the company.read more