Operating Income

The next equation helps us get to operating income, which helps us understand a company's core business profitability!

Let’s look at the second equation in the Income Statement:

Gross Profit - Operating Expenses = Operating Income 💼

Operating Expenses are the ongoing costs of running a business that are NOT directly tied to the production of goods or services 🏢

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 💡

By subtracting Operating Expenses from Gross Profit, we get Operating Income, which is the profit from a company's core business operations 📈

Let’s go back to our T-shirt company with a Gross Profit of $6,000 🧮

In addition to COGS, the company also spends $500 on rent, $500 on employee wages and $1,000 on marketing 🛍️

By adding these up, we can see that they have $2,000 of operating expenses 🔍

As a result, their operating income would be $6,000 - $2,000 = $4,000 💵

To compare the profitability of different companies’ operations, you can use Operating Margin, which is Operating Income ➗ Revenue

This shows how efficient a company's core business operations are!

The T-shirt company’s operating margin would be $4,000 ➗ $10,000 = 40% 🔢

This means the company keeps 40% of its revenue as operating income 💰

Operating Income is also called EBIT, or Earnings before Interest and Taxes, because it accounts for all expenses other than interest and taxes ⚖️

This will become important soon!

Test your knowledge

What are Operating Expenses?

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What do you get by subtracting Operating Expenses from Gross Profit?

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Which of these might be an Operating Expense for a T-shirt company?

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How do you calculate Operating Margin?

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What is another name for Operating Income?

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What's next?

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