Operating Earnings Definition Formula How To Calculate

Operating Earnings Definition

Explanation

Operating Earnings is the number of profits that the company earns from its core operations. It is one of the important concepts that help the investors and creditors know about the profit the company is generating from its core business.

To calculate the company’s operating profit, we need to understand and distinguish between various types of costs and how they appear in our Income StatementIncome StatementThe income statement is one of the company’s financial reports that summarizes all of the company’s revenues and expenses over time in order to determine the company’s profit or loss and measure its business activity over time based on user requirements.read more. There are three types of financial statementsTypes Of Financial StatementsThere are three types of financial statements, i.e., Balance Sheet, Income Statement and Cash Flow Statements. These written records facilitate the analysis and comparison of an organization’s financial position and performance.read more Income Statement, Balance Sheet, and Cash Flow Statement. The income statement shows the profitability of the company. Balance sheets show the Assets and Liabilities of the company. And the use of the Cash flow statement is to know about cash inflows and outflows of the company. Operating profit is a part of the Income Statement of the company.

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Operating Earnings Formula

There are three formulas to calculate Operating Earnings:

Total Revenue: This is the total sales revenueSales RevenueSales revenue refers to the income generated by any business entity by selling its goods or providing its services during the normal course of its operations. It is reported annually, quarterly or monthly as the case may be in the business entity’s income statement/profit & loss account.read more earned by the company by selling its goods to the customer. Let’s understand the different terms used in the above formulas.Direct Costs: Direct costsDirect CostsDirect cost refers to the cost of operating core business activity—production costs, raw material cost, and wages paid to factory staff. Such costs can be determined by identifying the expenditure on cost objects.read more are the expenses directly associated with the cost of manufacturing any goods or providing any service. E.g., labor costLabor CostCost of labor is the remuneration paid in the form of wages and salaries to the employees. The allowances are sub-divided broadly into two categories- direct labor involved in the manufacturing process and indirect labor pertaining to all other processes.read more, raw material cost.Indirect Costs: These are the cost which cannot be directly linked with the manufacture of a product. These are also called as overhead costsOverhead CostsOverhead cost are those cost that is not related directly on the production activity and are therefore considered as indirect costs that have to be paid even if there is no production. Examples include rent payable, utilities payable, insurance payable, salaries payable to office staff, office supplies, etc.read more. E.g., Rent and salary costs.Gross Profit: We calculate Gross Profit or Gross Income by subtracting the Cost of Goods Sold from Revenue.Operating Expense: These are the expenses incurred in running the core business. E.g., Rent, wages, and Insurance cost.Depreciation & Amortization: It is the cost of wear and tear of tangible and intangible assetsIntangible AssetsIntangible Assets are the identifiable assets which do not have a physical existence, i.e., you can’t touch them, like goodwill, patents, copyrights, & franchise etc. They are considered as long-term or long-living assets as the Company utilizes them for over a year. read more.Non-Operating Income: Income earned from other than the core business activities; E.g., profit from the sale of assets.Non-Operating Expense: Expenses not related to the running of the core business. E.g., interest cost and taxes.

How does Operating Earnings Work?

The Operating Profit works as per the below order. First, we have a Sales revenue figure from which we reduce COGSCOGSThe Cost of Goods Sold (COGS) is the cumulative total of direct costs incurred for the goods or services sold, including direct expenses like raw material, direct labour cost and other direct costs. However, it excludes all the indirect expenses incurred by the company. read more, i.e., the cost of goods sold, which includes Raw material cost, wages cost, etc., to get Gross Profit. Other Operating expenses such as Rent, insurance, depreciation, etc., are reduced from Gross ProfitGross ProfitGross Profit shows the earnings of the business entity from its core business activity i.e. the profit of the company that is arrived after deducting all the direct expenses like raw material cost, labor cost, etc. from the direct income generated from the sale of its goods and services.read more to get Operating profit figures.

There is another method to calculate Operating profits. We can start from the bottom of the income statement, i.e., take the Net Profit figure and add interest 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 and Taxes to get the operating profit of the company.

Example

There is a Shoe Manufacturing Company, calculate Operating Profit from below provided information.

Sales Revenue $3,00,00,000 Cost of Goods Sold $1,00,00,000 Marketing & Sales Expense $20,00,000 Office and Admin Cost $10,00,000 Depreciation Cost $20,00,000 Interest Cost $10,00,000 Tax rate 30%.

Solution

Calculation of Operating Earnings

The Operating Earnings = Total Revenue – COGS – Indirect Costs

= 3,00,00,000 – 1,00,00,000 – (20,00,000 + 10,00,000 + 20,00,000)= 1,50,00,000

Operating Income = Gross Profit – Operating Expense – Depreciation & Amortization

= 2,00,00,000 – (20,00,000 + 10,00,000) – 20,00,000= 1,50,00,000

Operating Income = EBIT – Non-Operating Income + Non-Operating Expense

= 1,50,00,000 – 0 + 0= 1,50,00,000

Net Profit

=14000000-4200000Net Profit = 9800000

Importance

It is an important indicator of how a business is performing. It is also used in calculating various financial ratiosFinancial RatiosFinancial ratios are indications of a company’s financial performance. There are several forms of financial ratios that indicate the company’s results, financial risks, and operational efficiency, such as the liquidity ratio, asset turnover ratio, operating profitability ratios, business risk ratios, financial risk ratio, stability ratios, and so on.read more.

Creditors, Investors, and Management closely monitor the EBIT of the company to track the company’s performance. This is an important aspect to consider while deciding to invest, as investors can compare the different companies at their operating levels.

Operating Profit is an indirect measure of the Company’s profitability. Higher the operating incomeOperating IncomeOperating Income, also known as EBIT or Recurring Profit, is an important yardstick of profit measurement and reflects the operating performance of the business. It doesn’t take into consideration non-operating gains or losses suffered by businesses, the impact of financial leverage, and tax factors. It is calculated as the difference between Gross Profit and Operating Expenses of the business.read more, the more profitable a company is.

Conclusion

Hence, Operating Earnings is an important concept that helps know about the company’s financial health. Although Net Profit plays an important role in understanding the company’s financial health, if we are comparing companies with different tax structures and finance structures, then the Operating profit will give us a more accurate picture.