Operating Profit
March 24, 2025
What is Operating Profit?
Operating profit is the total profit a company generates in a given accounting period from all its operating activity. It can be found on the Income Statement and is calculated by subtracting all operating costs not directly associated with production (selling, general & administrative expenses) from the gross profit.
It is an important figure and attracts investor interest as it shows the profit generated when not including unavoidable expenses, such as interest or income tax. It is used for many financial metrics and links closely to EBIT and EBITDA.
Key Learning Points
- Operating profit is reported in the income statement and represents the profits before the impact of financing and taxation expenses and other non-operating expenses
- For many companies, this profitability figure is equal to EBIT (Earnings before interest and taxes)
- Analysts use this figure to measure the operational performance and profitability of a company, particularly looking for year-over-year improvements
- Many companies report operating profit as “operating income” and these terms can be used interchangeably
- Operating margin is a useful comparison metric and expresses operating profits as a percentage of revenues
- Operating ratios can be used to compare a company’s operating performance to that of peers as well as its own prior performance
Calculation of Operating Profit
Operating profit is calculated by taking a company’s sales (or revenue) over the period, and subtracting the cost of goods sold, as well as selling, general, and administrative expenses.
Operating Profit Formula
Operating profit is calculated by subtracting operating expenses, the cost of goods sold, and other day-to-day expenses from total revenue. Operating profit measures earnings before financing and government costs. It represents the profit generated from the operations of a company and is reported after revenue and any expenses associated with the operations of the business such as COGS and SG&A. Many companies report it as “operating income” and these terms can be used interchangeably.
Operating Profit Margin Formula
One of the key metrics operating profit can be used for is the Operating Profit Margin. This indicator takes the operating profit within a given period and divides it by the sales for that same period. It is expressed as a percentage and is useful for looking at how the company’s operations have performed compared to the prior period. It can also be used to compare performance to the peer group or the sector average.
Example of Operating Profit Margin
Using Coca-Cola’s reported operating profit of $7,501m and sales of $35,410m at the end of their 2017 financial year, we can calculate the operating margin for the company.
The Coca-Cola Company – Income Statement 2017
Lets look at the calculation for Coca-Cola’s Operating margin in 2017:
- Operating Margin = Operating Profit / Sales for the period
- Operating Margin = 7,501 / 35,410
- Operating Margin = 0.212 (or 21.2%)
What Does Operating Margin Show?
Taking our example for the Coca Cola company, operating margin shows that for every $100 sale made, $21.20 contributes towards the operating profit of the company. In this case, the margin is relatively high and shows Coca Cola are managing their costs in order to generate a good percentage of profit. If a company was unable to generate any profit, the margin would be negative and a major concern for the company.
Operating margin must always be put in context of the company’s prior and estimated performance. It must also be relative to the peer group, other companies of a similar size and scale, and companies which also operate within the same region. It is up to the analyst looking at the company to decide which are the best comparables for a company.
There are many factors which can affect the operating profit margin, so it is a great reflection of management’s operating decisions. The margin will reflect revenue drivers such as the pricing strategy and market conditions, as well as cost factors such as the price of materials and direct labor costs.
In normal market conditions a company would look to improve its operating margin annually to reflect improved sales and cost controls within the operations. A company looking to acquire another company (merger or acquisition) will want to assess areas of operational improvement (such as reducing high costs or improving marketing strategies) in order to generate higher revenue.
Operating margin is only a figure on its own and is best used when comparing to similar industries or historical data. It is important to remember that different industries use varying business models so ratios only make sense in context.
Comparing Operating Profit to Other Profit Measures
Let’s now look at other profit figures from the Income Statement and compare them to operating profit:
Operating Profit vs. Gross Profit
Gross profit is the ‘earliest’ form of profit as we work our way down the Income Statement as it is simply revenue minus the cost of goods used to produce the goods. It is the profit a business makes from sales generated by selling a product or a service and deducting the cost of goods sold (COGS) and production expenses.
Operating profit is very similar to gross profit in that it includes COGS, but it also includes selling, general and administrative expenses (SG&A). These are the additional costs associated with running the company’s operations rather than simply the direct production of the goods. It can include the cost of sales teams (offices and labor), general expenses and administrative costs such as head office costs and others associated with the business.
Operating Profit vs. Earnings Before Interest and Taxes (EBIT)
EBIT refers to Earnings before Interest and Tax which is calculated as taking pre-tax earnings and adding back the interest costs. EBIT and operating profit can be considered as interchangeable but there are some important distinctions between the two:
- Operating profit only captures the operating performance of the business
- EBIT calculations include non-operating income and expenses
- EBIT looks at the company as a whole including profits from aspects of the business which are not considered operations
It is important for analysts to check how a company defines its operating profit (or operating income) and EBIT. EBIT will also strip out non-recurring events such as restructuring or one-off gains (or losses) as they may impact operating performance and make it difficult to see how the underlying business is performing.
EBIT Formula
Access the free Financial Edge template showing how to correctly calculate operating profit and EBIT.
Operating Profit vs. Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA)
While operating profit focuses on the profitability of core business operations, EBITDA provides a more comparable measure of performance by eliminating the effects of depreciation and amortization. EBITDA is an accounting measure that removes depreciation and amortization from the profit calculation. If we consider two companies which are identical except for their depreciation policies: one company used straight-line depreciation for all its assets, and another used double-declining balance depreciation. This will impact the operating profit calculation. By stripping this accounting methodology out we see that operating profit is useful for understanding the performance of core business activities, while EBITDA is useful for comparing companies with different depreciation policies.
Operating Profit vs. Net Profit
Operating profit focuses on the profitability of core business operations, while net profit provides a comprehensive measure of overall profitability of the company. Net profit is calculated by taking operating profit and then factoring in all the other costs of running a company, such as any interest costs (to service loans) or interest paid (cash in bank), other non-core parts of the business and of course tax which must be paid to the state where the business is based. Net profit is known as the ‘bottom line’ and is the company profit after all other costs have been accounted for. It is useful for assessing the overall financial health of a company.
Conclusion
Operating profit is a crucial metric for assessing a company’s core business performance, excluding financing and taxation expenses. It provides valuable insights into how effectively a company manages its operational costs to generate profit, making it a key indicator for investors and analysts for the health of the company.