Letโs look at the second equation in the Income Statement:
Gross Profit - Operating Expenses = Operating Income ๐ผ
Operating Expenses are the ongoing costs of running a business that are NOT directly tied to the production of goods or services ๐ข
With our T-shirt company, operating expenses may include rent for the store used to sell T-shirts, employee wages, marketing costs associated with promoting T-shirts and more ๐ก
By subtracting Operating Expenses from Gross Profit, we get Operating Income, which is the profit from a company's core business operations ๐
Letโs go back to our T-shirt company with a Gross Profit of $6,000 ๐งฎ
In addition to COGS, the company also spends $500 on rent, $500 on employee wages and $1,000 on marketing ๐๏ธ
By adding these up, we can see that they have $2,000 of operating expenses ๐
As a result, their operating income would be $6,000 - $2,000 = $4,000 ๐ต
To compare the profitability of different companiesโ operations, you can use Operating Margin, which is Operating Income โ Revenue
This shows how efficient a company's core business operations are!
The T-shirt companyโs operating margin would be $4,000 โ $10,000 = 40% ๐ข
This means the company keeps 40% of its revenue as operating income ๐ฐ
Operating Income is also called EBIT, or Earnings before Interest and Taxes, because it accounts for all expenses other than interest and taxes โ๏ธ
This will become important soon!