Difference Between Operating Income and Net Income

Both are essential metrics in financial accounting statements. Operating income is the income generated by the day-to-day operations or, in other terms, the core activities of a business. It is calculated after deducting the cost of operations from the total sales.

Mathematically, it can be expressed as:

Net income is the bottom line. The final profit is available for the shareholders after deducting interest expenses, any extraordinary income or expense, and taxes.

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The above equation helps us identify the relationship between operating and net income. Operating income, on the one hand, identifies the income generated from the operating activities of the business; net income, on the other hand, quantifies any income generated by the business entity either from operations or from interests earned from investments or even an income generated by liquidating an asset. Operating income is a subset of a bigger umbrella called Net income.

Example

Consider the income statement of an ABC company.

Here 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 has been calculated by deducting the cost and expenses from the total sales. However, to calculate net income, total expenses are deducted from total income, and then tax is levied. Also, as illustrated, net income is the bottom line and the final number on the income statement as one follows the top-down approach. Operating income is just a subset used in calculating the net income.

Operating Income vs. Net Income Infographics

Critical Differences Between Operating Income and Net Income

The key differences are as follows –

#1 – Significance

Operating income is the most significant section in the income statement of any business unit. It is because it helps identify the income generated from the primary business activities of the firm. It does not consider any one-time expense or any one-time income. Hence it is free from any manipulations and gives a clear picture of the robustness of the operational activities of the business. Analysis of operating income for consecutive quarters can help an investor identify the profitability of the business and the growth opportunities it can provide for the long term.

Net income, on the other hand, is the final profit available for the shareholders after all expenses and income have been taken care of. Hence it is called a bottom lineBottom LineThe bottom line refers to the net earnings or profit a company generates from its business operations in a particular accounting period that appears at the end of the income statement. A company adopts strategies to reduce costs or raise income to improve its bottom line. read more and used to pay out the dividends. Unlike operating income, it does contain any one-time expense or one-time income. For example, consider a pharma company with a robust operating income that has been penalized by regulators. This one-time payment will not affect the operating income but will impact the net income and, eventually, the profit available to the shareholders. Therefore, investors should carefully analyze both incomes before parking their money.

# 2 -Taxes and uses

Operating income only takes care of revenue generated and the cost of operations. Net income takes care of not only revenue, costs, expenses, one-time expenses, taxes, and surchargesSurchargesA surcharge is an extra fee or tax added to the customer’s final bill for paying through check, credit, or debit card rather than cash. The additional sum reflects the extra services offered by the merchant, increased product costs, or government regulatory costs. It could be either a fixed amount or a percentage of the purchase amount. read more. Therefore, sometimes you might see a big number on the operating income section of the balance sheetBalance SheetA balance sheet is one of the financial statements of a company that presents the shareholders’ equity, liabilities, and assets of the company at a specific point in time. It is based on the accounting equation that states that the sum of the total liabilities and the owner’s capital equals the total assets of the company.read more, which gets completely wiped off in the bottom line. Since net income denotes the profitability of the firm, it is used in calculating parameters like EPS, return on equityReturn On EquityReturn on Equity (ROE) represents financial performance of a company. It is calculated as the net income divided by the shareholders equity. ROE signifies the efficiency in which the company is using assets to make profit.read more, and return on assets. Shareholders are mainly interested in these ratios, as these will only determine if their investments have been worthwhile.

Comparative Table

Final Thought

Operating and net income are essential parameters while judging the firm’s financial health. Long-term investors will be more interested in understanding the robustness of the core business activities of the firm. Hence they will monitor the operating income with a close eye. However, short-term traders will be more interested in the bottom line numbers as that will determine the earning potential of their speculative bets.

That is why most of the time, you will see a sharp dip in a listed firm’s share price whenever there are short-term setbacks like losing a lawsuit or being penalized by regulators. However, most of the time, these are an overreaction by the short-term traders concerned about near-term profitability, and most often, share prices bounce back. For example, the Maggi ban in India had a massive impact on Nestle India Ltd shares, which dropped by 50% in 4 weeks before bouncing back to their initial levels within two quarters.

This article has been a guide to Operating Income vs. Net Income. Here we discuss the top difference between Operating Income and Net Income, infographics, and a comparison table. You may also have a look at the following articles –

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