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What is operating profit?
If you are a business, your operating profit is paramount. Not only is it an indicator of your operational success, it is also a key indicator of your profitability and efficiency. If your operational costs outweigh your operational profits, it will require major changes from your business because it will cost you money.
Read on to learn more about this important concept, including how it’s calculated and how to boost your business’ operating profit.
Contents
What is operating profit?
How to Calculate Operating Profit
Why is operating profit important?
How to boost your operating profit
What is operating profit?
A company’s operating profit is its share of revenue, after deducting cost of goods sold (COGS) and operating expenses. Conceptually, it’s the highest-end amount of revenue your business has after deducting the cost of making your products and running your business.
On a company’s profit and loss (P&L) statement, it is found after COGs and operating expenses. Some have it as a separate line item on its own; In others, it must be calculated.
Operating profit is one of many line items companies and analysts use to evaluate companies; Another that is frequently monitored is gross profit. Although similar, these concepts are very different: gross profit is revenue, net of cogs. It does not take into account the operational expenses of the business, such as sales and marketing expenses, general and administrative expenses, etc.
Gross profit measures how well a business can generate profit from direct labor and direct materials, while operating profit is the net income derived from the core or core operations of a business – and therefore, is a very accurate indicator of a company’s health.
While many also refer to it as earnings before interest and tax (EBIT), EBIT and operating profit are actually different – because operating profit does not include non-operating income, but EBIT. . So, if a company has no non-operating income, its operating profit will be equal to its EBIT.
How to Calculate Operating Profit
There are two different options for calculating operating profit:
- Revenue – (COGS + Operating Expenses)
- Gross profit – operating expenses
Let’s illustrate with an example.
|
Baledom Inc. |
May 2022 |
|
Total revenue |
,400 |
|
Cost of Goods Sold |
,100 |
|
Gross profit |
,300 |
|
General Administration |
,200 |
|
Sales and Marketing |
,150 |
|
Operating profit |
,950 |
In May 2022, you earned ,400 in income. If we were to use the first calculation, we would add COG (,100) and total expenses (,200 + ,150), and subtract that sum from revenue to receive ,950 in operating profit.
If we use the second method, from the gross profit (,300), we subtract the operating expenses (,200 + ,150), which would yield the same result, of ,950 in operating profit. operation.
In the event that the operating profit is negative, it means that the operating expenses are greater than the income brought in by the operations. For companies in their incentive, this is understandable and perhaps even expected at the very beginning. However, if a company’s operating profit is continuously negative, it will eventually lead to insolvency.
Why is operating profit important?
A company’s operating profit is a very accurate indicator of its business and financial health, as all irrelevant, non-operating factors are removed from the equation, and only operating expenses and profits remain. It therefore reveals a very true picture of how a business is going, operationally.
What remains are the expenses necessary to keep the business running, including depreciation and amortization related to assets.
Operating profit is very important to investors and outside shareholders, because of this – the undiluted picture of the actual business health of the company.
How to boost your operating profit
If you are a business owner or COO and want to increase your operating profit, there are two ways to do it. They’re frankly unsurprising and sometimes not very straightforward: either you i) increase revenue (inflows) to your business, or ii) cut back and reduce expenses, to increase your profit margins. Or, you try to do both.
Revenue increase
That probably sounds easier said than done. One way to do this is to increase sales – can your company/business add new marketing strategies, enter and capture new markets and/or customers? Can you expand, create new revenue streams or relief, or add additional services?
An unpopular strategy raises prices, which would obviously increase your margins but could make you unpopular with customers.
Reduce expenses
In common parlance, many refer to it as cost cutting. Operating expenses are essential to your business, so they are difficult to decrease, although it is possible and will require a fine-toothed comb with an accountant to identify expenses that can be minimized.
The inner workings of a business are intrinsically tied to the value and quality of your product and/or service, so reducing COGS can come in the form of cutting unnecessary expenses, entering into contract renegotiations with your current Suppliers – or even to find newer and more competitive Suppliers.
Lower expenses can also come in the form of adopting more efficient technologies, such as automating different parts of the business or combining roles where possible. Offering employee incentives as part of a downsizing process is also a common and proven strategy.
Stay on top of your operating profit with FinModelsLab predefined and easy to use Profit and Loss (P&L) Projection Guide, with real examples and explanations. Make complex, simple!
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