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July 13, 2022
There is an abundance of financial records founders must understand and monitor to see their company’s financial health. Profitability is an important metric to measure; it shows that your company is heading in the right direction. Calculating operating income is one of the best ways to assess a company’s profitability and operational efficiency and a metric that investors will want to see.
A high operating income shows profitability, while a low or decreasing number means there are problems in operational expenses. To determine profitability, you need accurate numbers to input into the formula, which we will describe below.
Income from operations is the metric investors use to decipher a company’s overall management of cash flow and budgeting. Investors and founders can look at these numbers in contrast with direct market competition to see if any improvements need made.
It may seem like an odd practice to include a total profit without subtracting other expenses or adding additional income. There is a method to the madness. Operating income breaks apart the operational process of a business from other expenditures.
A profitable business can go under when operational expenses override net income. Operating income statements pinpoint where the issues lie.
You can calculate operating income by subtracting operation-related expenses from gross income (or gross profit).
Gross Income - Operating Expenses = Operating Income
For example, company X had a stellar month with a gross income of $14.2 billion with operating expenses totaling $3.7 million, leaving the company with $10.5 billion in operating income.
$14.2 billion - $3.7 million = $10.5 billion
Depending on the month’s gross income, fluctuating operational expenses, and miscellaneous income, the difference between operating income and EBIT can be tremendous or non-existent.
Operational expenses are an unavoidable part of running a functional business. Spending money to make money shouldn’t cast a veil on proficient cash flow budgeting, though. When your operational expenses get out of hand, your burn rate can multiply twice as fast.
General operating expenses include:
Operating expenses, or OPEX, do not include SG&A (selling, general, and administrative expenses), depreciation, or amortization.
Step costs are a consistent expense for a given activity level, but the number increases or decreases after crossing a specific threshold.
For example, say a company produced 60 Bluetooth speakers a week with twenty technicians and two supervisors with wages and benefits equaling $70,000 per shift. The marketing hits all targeted demographics increasing the demand from 60 to 100 Bluetooth speakers weekly. The step cost is the increased benefits and wages needed after the company added ten new technicians and an operational manager.
Therefore, the step cost is the wages and benefits needed to produce the high demand for product.
Most businesses have similar operating costs, but each market niche can come with its unique operational costs. Likewise, some operational expenses reoccur annually while other fees are infrequent.
Other operating costs can include:
Other sources of income are a part of a company’s total net income but fall under EBIT. What operating income does not include, EBIT does. It accounts for all operational costs, income sources, and expenses..
Operating income (or operating profit) does not subtract the following:
As mentioned above, outside of the basic formula for operating income, you can also calculate operating income by factoring in EBIT: both are metrics needed to find profitability.
The big difference between operating income and EBIT is that EBIT includes interest and tax expenses while operating income alone does not.
Operating Income: a company’s gross income after subtracting operating expenses from total revenue, including taxes and interest.
EBIT: a company’s net income before subtracting income tax expenses and interest expenses.
Stability and profitability are what investors want to see from startups in their first few years. Venture capitalists aren’t necessarily looking for the next unicorn. However, they want their investments to be fruitful.
Operating income takes an essential chunk of a company’s income and spreads the numbers on the table for founders and investors to inspect. A good CFO will know the ins and outs of a company’s daily operations and operational expenses compared to gross income. Your CFO should be updating records dutifully and correctly to provide investors with an accurate depiction of a company’s profitability.
Our CFO services at Zeni do just that. Not only do we have your operating expenses visible by month, quarter, and year, but we also break down exactly what classes and departments your money goes into. You’ll have a categorized breakdown of which expenses are eating up the largest portion of your budget. Our dashboard updates each account in real-time as transactions flow in and out, allowing you to adjust finances in the moment.