Operating income and net income are two financial metrics that display your startup’s earnings. While both present two different pictures of your startup’s profits, each is important in its own way.
Your goal is to maintain a balance between the two, looking at both of these metrics individually and comparing them to come to different conclusions about the financial health of your business.
This article will explain how to compare operating and net incomes. You’ll also learn how to manage and leverage each of them to make smart decisions for your startup.
Operating Income Definition
Operating income is your startup’s income after deducting all the necessary daily costs to keep you in business (or your operating expenses). We go into much more detail on operating expenses (OpEx) here, but this generally includes items like rent, payroll, marketing, or inventory – anything your business can’t operate without.
You can also find operating income by subtracting your OpEx from your gross profit Operating income is also calculated by subtracting operating expenses from gross profit.
Your operating income tells you if you’re making enough money to produce your product or offer your service. Moreover, managing your operating income helps you assess your spending.
Net Income Definition
Net income is the final take-home amount after subtracting all expenses from your gross profit. These expenses include everything that makes up your operating costs plus other administrative costs, such as taxes, interest payments, and debts (non-operating expenses).
Gross revenue also includes non-operating income, which is your earnings outside your core business operations. Asset sales, earned interest, and investment gains are examples. Even investment losses are a part of your net non-operating income.
One thing to caution with net income is that since this metric includes non-operating income, you could be seeing an inaccurate picture of your earnings because this income often only happens once or on occasion.
Comparing Operating Income vs. Net Income
The difference between operation and net income comes down to what exactly is deducted from your startup’s gross income. Operating income is only what you earn after direct and indirect costs are subtracted from gross profits. However, net income is your bottom line. It’s what you earn after direct, indirect, and all other administrative costs are subtracted from gross profits.
While these metrics have different meanings for your business, they also complement each other to display a clearer picture of your startup’s financial performance. You must keep a proper balance between both metrics to stay in business now and expand later when you’re ready.
For example, imagine company A has a high operating income because the owner keeps labor and material costs down. But the net income may be as not ideal. Perhaps the owner misfiled their taxes and lost out on many breaks, or the owner has a lot of business loan debt to pay with due dates quickly approaching.
A high operating income combined with a low net income means that the business can expand only if the owner dips into profits, as investors are likely not to get involved. Furthermore, perhaps business growth means the owner has to use up all profits to achieve that, resulting in an unprofitable fiscal year.
In this example, company A’s net income may actually be negative, making business growth just about impossible, let alone staying in business at all.
It’s not any better if company A has a low operating income and a high net income. Forget about attracting outside investors, as this startup’s owner isn’t investing enough of their own funds into products and services to stay in business for very long.
A financially healthy startup shows a high enough net income to remain in business with opportunities to expand while maintaining an operating income low enough to stay competitive and attract customers.
How To Manage Operating Income And Net Income As A Startup
Managing your startup’s operating and net income is easier than you think. Before you started your company, you created a business plan that projected where all of your money would go. Now that your startup is underway, you need another plan to better understand exactly where your money is going and how that maps back to your overall budget.
Consider the advantages of automated accounting software to track operating income and net income in real time, keeping your financials organized and easily accessible. Daily reports on your operating expenses help you keep a close eye on what you’re spending and how you’re spending, which is just as important.
Accounting software lets you view your financial performance history by noticing trends and finding opportunities to make necessary changes to achieve stability. Sporadically checking in on this data means you’re only seeing a small snapshot at a time, which doesn’t help you with financial forecasting.
The Bottom Line To Understanding Startup Income Metrics
Operating and net incomes each play a significant role in your startup’s potential success. Avoid concentrating your efforts on one without the other. Operating income determines the efficiency of your production, services, and sales.
However, net income gives a holistic view of your startup’s financial health. Financial accounting allows you to wisely manage each income, helping you see how they work together to reach and exceed fiscal stability.