Earnings Before Interest & Taxes Show
What is Operating Income?Operating income, also referred to as operating profit or Earnings Before Interest & Taxes (EBIT), is the amount of revenue left after deducting the operational direct and indirect costs from sales revenue. It can also be computed using gross income less depreciation, amortization, and operating expenses not directly attributable to the production of goods. Interest expense, interest income, and other non-operational revenue sources are not considered in computing for operating income. Below is an example of income from operations highlighted on Amazon.com Inc.’s 2016 income statement. Source: Amazon.com Inc.Formula for Operating incomeThere are three formulas to calculate income from operations: 1. Operating income = Total Revenue – Direct Costs – Indirect Costs OR 2. Operating income = Gross Profit – Operating Expenses – Depreciation – Amortization OR 3. Operating income = Net Earnings + Interest Expense + Taxes Sample Calculation D Trump footwear company earned total sales revenues of $25M for the second quarter of the current year. For that period, the cost of raw materials and supplies used for the sold products was $9M, labor costs directly applied were $2M, administrative and staff salaries totaled $4M, and there were depreciation and amortizations of $1M. As a result, the income before taxes derived from operations gave a total amount of $9M in profits. What are Revenue and Gross Profit?Sales revenue or net sales is the monetary amount obtained from selling goods and services to business customers, excluding merchandise returned and any allowances/discounts offered to customers. This can be realized either as cash sales or credit sales. On the other hand, gross profit is the monetary result obtained after deducting the cost of goods sold and sales returns/allowances from total sales revenue. What are Direct Costs?Direct costs are expenses incurred and attributed to creating or purchasing a product or in offering services. Often regarded as the cost of goods sold or cost of sales, the expenses are specifically related to the cost of producing goods or services. The costs can be fixed or variable but are dependent on the quantity being produced and sold. Examples of directs costs are:
What are Indirect Costs?Indirect costs are operating expenses that are not directly associated with the manufacturing or purchasing of goods for resale. These costs are frequently accumulated into a fixed or overhead cost and allocated to various operational activities. Examples of indirect costs are:
Examples of selling and administrative indirect costs are:
Operating Income = EBITAnother way to calculate income from operations is to start at the bottom of the income statement at Net Earnings and then add back interest expense and taxes. This is a common method used by analysts to calculate EBIT, which can then be used for valuation in the EV/EBIT ratio. Below is an example calculation of EBIT:
Learn more about EBIT and EBITDA here. Download the Free TemplateEnter your name and email in the form below and download the free template now! Operating Income TemplateDownload the free Excel template now to advance your finance knowledge! What is the Importance of Operating Income in Business?Operating income is considered a critical indicator of how efficiently a business is operating. It is an indirect measure of productivity and a company’s ability to generate more earnings, which can then be used to further expand the business. Investors closely monitor operating profit in order to assess the trend of a company’s efficiency over a period of time. Operating profit, like gross profit and net profit, is a key financial metric used to determine the company’s worth for a potential buyout. The higher the operating profit as time goes by, the more effectively a company’s core business is being carried out. More ResourcesThank you for reading CFI’s guide to Operating Income. If you’re interested in advancing your career in corporate finance, these CFI articles will help you on your way:
Which expenses are subtracted from gross profit to arrive at income from operations?Operating Income = Gross Profit - Operating Expenses
Operating expenses are subtracted from gross profit.
What is subtracted in arriving at operating income?Operating income is what is left over after a company subtracts the cost of goods sold (COGS) and other operating expenses from the sales revenues it receives. However, it does not take into consideration taxes, interest or financing charges.
What is subtracted from gross profit?Net income is gross profit minus all other expenses and costs as well as any other income and revenue sources that are not included in gross income. Some of the costs subtracted from gross to arrive at net income include interest on debt, taxes, and operating expenses or overhead costs.
Which of the following items should be deducted from the gross profit to arrive?Answer and Explanation: The correct answer is Option a. These are selling, admin & other general expenses made by the company in the process of manufacture & sale of its products, which are not assignable directly to any products. They are reduced from gross profit to get the net income figure.
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