Analysts and investors measure companies in various ways, many relating to the amount of profit produced in a given time. Operating income measures the performance of the company’s core operations. This number gives some of the clearest forecasts for company performance.
What Is Operating Income?
Operating income shows a company’s profit after deducting operating expenses. Various operating expenses include salaries and wages, depreciation, cost of goods sold (COGS), and items like utilities and office supplies. Also, this accounting measure includes selling, general, and administrative costs (SG&A), such as advertising.
Operating Income = Net Sales – COGS – Operating Expenses
Furthermore, operating income excludes actions such as investment in outside firms, or the sale of real estate (given the company is not in business to sell land). Expenses such as taxes and interest expenses do not qualify as operating income. The simplest explanation for operating income is if the cost supports the company’s core business practice. Additionally, one may wonder why financing charges such as interest are not included. Operating income judges a company’s efficiency from core operations and how they fare in the market. Interest is a necessary part of business and has no relation to market demand or operating efficiency.
Operating Income In Practice
This section of income goes one step beyond gross income. It gives a complete picture of how a company measures up to others in its space. Additionally, discrepancies between like companies allow investment opportunities. For example, a company with a greater operating income has more money to either return to shareholders, or pursue new projects.
Conversely, savvy investors notice that companies with high operating income, but low net income deduce that the future will be better- perhaps the company had a large lawsuit bill as a one time expense. If the company’s stock shows a negative reaction based on net income numbers, but operating numbers remain strong, investors buy weakness believing current prices trade at a discount.
Operating income is yet another accounting measure of a company’s performance. This measure is industry specific and typically is of no use across industries. Successful analysts focus on core operations in predicting future values of companies.