Operating Earnings

Operating Earnings or Operating Income is the profit a company earns from its core business activity after deducting operational direct and indirect costs from sales revenue. It is also known as EBIT, i.e., earnings before interest and taxes. We don't consider interest, taxes, and other non-operating income while calculating Operating Income.

Adjusted operating earnings is a useful tool as it does not include one-off expenses or entries that might affect the net profit of the company for a specific accounting period. It is a culmination of both internal and external factors that represent how the company makes a profit and how much of the same is made within a specific period.

Operating Earnings is the quantum of profits that the company earns from its core operations. It is one of the important concepts that help 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 Statement. There are three types of financial statements 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.

For shareholders and other investors too, it acts as an important metric since it shows how the company makes money from its operations and how much it is able to make. This gives them an ultimate outcome through calculating operating earnings per share which gives them a clear idea about if it is a good investment or if it can be avoided.

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.

Let us understand the formula to find adjusted operating earnings. This shall act as a basis for our understanding of the concept and its related factors.

• Total Revenue: This is the total sales revenue 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 costs are the expenses directly associated with the cost of manufacturing any goods or providing any service. E.g., labor cost, 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 costs. 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 assets.
• 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.

Multiple components come together to form the process of calculating and formulating the operating earnings per share. Let us understand how to calculate through the detailed explanation below.

The Operating Profit works as per the below order. First, we have a Sales revenue figure from which we reduce COGS, 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 Profit 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 expense and Taxes to get the operating profit of the company.

Let us understand the concept of common and adjusted operating earnings with the help of a couple of examples. These examples shall help us understand the concept and its intricacies in detail.

Example #1

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

• =14000000-4200000
• Net Profit = 9800000

Example #2

Berkshire Hathway, the multi-national conglomerate experiences a 12% jump in their operating earnings in 2023. Their cash hoarding increased to a mammoth $130 billion. For the same period in the previous year the amount was $7.6 billion.

The majority of the contribution towards the sharp increase in their profits came from the conglomerate’s insurance underwriting arm. The earnings from this section of their business jumped from $167 million to $911 million in one year.

Despite a few businesses such as the railroad business (BNSF), energy, and auto insurance showing declines in revenues, overall, the company’s net earnings jumped from $5.6 billion to $35.5 billion for the same quarter in the previous year.

Let us understand the importance of determining the operating earnings per share through the points below.

• It is an important indicator of how a business is performing. It is also used in calculating various financial ratios.

• 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 income, the more profitable a company is.

While both adjusted operating earnings and net income are metrics of high significance to the company, there are a few major differences in their fundamentals and implications. Let us understand them through the comparison below.

Operating Earnings

• It refers to the income generated by an organization from its core income-generating activities within a specific period.
• It helps investors, stakeholders, and management to determine how much revenue generated is converted into profits.
• Taxes and other non-operating expenses as a part of its calculations as it might skew the net profit of the business with one-off expenses within the period.
• It is an efficient tool to calculate the returns generated through the capital employed.
• It is calculated by deducting gross income from operating expenses, depreciation, and amortization.

Net Income

• Net income refers to the profits generated by a business through the core and other activities within a specific period.
• It signifies the earning potential of a business.
• It also deducts taxes and other such expenses before a final figure is arrived at.
• It is a tool used for calculating earnings per share, return on assets, and return on equity.

This has been a guide to Operating Earnings and their definition. Here we explain its formula, how to calculate, examples, and compared it with net income. You may learn more about financing from the following articles –

• Operating Profit Formula
• Earnings Call - Definition
• Ordinary Income
• Operating Revenue - Definition