What is operating profit and how is it calculated?

Revolut Contributor

 · June 22, 2020  · 06/22/2020

Operating profit is the total revenue of a business over a given period, minus the direct costs of achieving this revenue as well as the day-to-day operating costs of the business. It does not take into account any tax due nor interest owed on bank loans.

What do you mean by operating profit?

Put simply, this is a measure of profitability that showcases the level of profits a company achieves once it deducts all the costs of running its core business operation. The resulting figure, sometimes called operating income, is closely watched on income statements. The main reason is because it highlights business efficiency and identifies potential cost savings.

How do you calculate operating profit?

The operating profit formula takes several forms. We show the two simplest below, but these are the same calculation given that gross profit {link RB1} is defined as revenue minus direct costs.

Operating Profit = Revenue – Direct Costs – Operating Expenses

Operating profit = Gross Profit – Operating Expenses

This can be confusing, as people use slightly different words to describe the same terms. For instance, revenue is often called total sales or turnover, yet it is merely the full value of what the business sold. Direct costs are commonly known as the cost of goods sold (COGS) and include variables needed to make the products, such as the raw materials.

Operating expenses are all the other costs involved in actually running the business. These include the rent on a premises, staff salaries. There is also a deduction for the allowances shown in the annual accounts for depreciation or amortisation of long-term assets that the business owns.

The figure for operating profit does not take into account any money that enters or leaves the business through drawings, nor additional income earned through investments.

Is operating profit the same as net profit?

In a word, no – even though the distinction is often subtle. Net profit is what is left after every allowable cost is deducted from revenue. This typically includes tax or interest on loans and is such a definitive measure of profitability that it is known as the bottom-line profit. This is also because net profit is, typically, the final number shown on the income statement.

By contrast, operating profit is a more nuanced measurement of business profits. Many investors prefer it to net profit as a metric because it reflects more of the day-to-day factors that are within the control of managers.

A closer parallel to operating profit is EBIT (Earnings Before Tax and Interest). Indeed, these are such similar calculations that some people describe them as the same thing. The difference is that operating profit excludes income generated outside of the standard revenue streams of the business – for instance, the profits from selling a stake that it owns in another company. Conversely, the EBIT figure will include this figure.

The operating profit of a business is a monetary value but, once it’s converted into a percentage of revenue, it then becomes the operating profit margin.

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