What is an Operating Profit & How to Calculate: Formula, Margin, Ratio, & Meaning
When it comes to a company's finances, the operating profit (OP) is viewed as an essential component in analyzing the revenue earned over a given period. There's a lot more to this term than merely some trade returns. Let us examine operating profits and why they are important to a business.
What Is an Operating Profit?
Operating profit (OP) is the income generated by a company's core operations, excluding all funding or tax-related concerns. The principle investigates a company's profit potential while excluding all external factors. If a company's OI (operating income) is negative, it will almost certainly require additional external funding to stay in business. Operating profit data is especially valuable when plotted on a trend line to determine how a company performs over time.
On a company's earnings statement, operating profit is reported as a subtotal after the administrative and general expenses and before the line items for interest revenue, interest expenditure, and income taxes.
Operating profit doesn't always equate to cash flows produced by a company because accounting entries made on the accruals concept can lead to operating profits that differ significantly from the cash flows documented.
Combative accounting methods, like shifting accounting reserves, evolving revenue recognition laws, and/or postponing or accelerating expense acknowledgement, can falsely increase operating profit.
Operating Profit Formula
Operating profit is computed by dividing operating revenue by operating expenses. The OP formula is as follows:
Operating profit (OP) = Operating revenue (OR) - Operating expenses (OE)
OP = Gross profit (GP) - Operating expenses
- Operating revenue is the total revenue generated by a business's core operations, like the sale of products and services.
- Operating expenses are the costs a company incurs during its operational processes, like wages and salaries, rent, utilities, and materials.
- Gross profit (GP) is the leftover revenue after subtracting the cost of goods sold (COGS) from operating revenue.
It's important to remember that operating profit excludes non-operating items like interest earnings or expenses, taxes, and investment losses or gains.
Example Of Operating Profit
Here is an example of calculating operating profit:
Assume a company sells handcrafted furniture. In a specified year, the company's OR (operating revenue) from furniture sales was $500,000, and its operating expenses were $400,000.
To determine the operating profit, we will have to subtract the operating expenses from the operating revenue:
Operating profit (OP) = Operating revenue - Operating expenses
Operating profit = $500,000 - $400,000
Operating profit = $100,000
As a result, the company's operating profit that year is $100,000.
It is crucial to remember that this is only an example and that operating profit can vary significantly between companies and industries.
Why is Operating Profit Important?
As previously stated, operating profit is a measure of profitability.
If your month-to-month operating expenses exceed your month-to-month GP (gross profit), you are operating at a loss. And several failed startups understand that a consistent cash loss indicates that your company is battling a losing battle.
Operating profit is also meaningful, particularly to extraneous investors and other stakeholders, because it excludes all inconsequential or external factors from the calculation, giving you a clear image of your company's health.
However, based on your debt, your OP may appear higher than your overall cash flow. For instance, if you lately made a significant purchase that has no impact on COGS, your operating profit may still not change, but it will still have an impact on your bottom line.
Operating Profit Margin in Regards to Operating Profit
Operating profit & operating margin are two closely linked metrics that provide information about a company's financial performance. However, they aren't the same thing.
Operating profit measures a company's profitability that shows how much revenue is left over once all operating expenses are paid. Operating expenses are subtracted from operating revenue to arrive at this figure.
Operating margin, on the contrary hand, is a measure of how efficiently a company uses its resources to make a profit. It is determined as a percentage by dividing operating profit by operating revenue.
For instance, if a business has a $100,000 operating profit and a $500,000 operating revenue, its operating margin would be:
Operating margin = (Operating profit / Operating revenue) x 100%
Operating margin = ($100,000 / $500,000) x 100%
Operating margin = 20%
Hence, the company makes a profit of 20 cents for each dollar of revenue generated.
Operating margin is a valuable metric for comparing the company's profitability to that of its competitors, and it is especially useful when comparing businesses in the same industry. A higher operating margin indicates that a business can generate a more significant profit from its operating revenue, implying that it's more effective and efficient than competitors.
Overall, while OP and OM are related, they provide different types of data about a company's finances and should be considered together while assessing its financial health.
Operating profit is a helpful financial metric that provides information about a company's profitability. It denotes the amount of money generated by a business's core operations after deducting all operating expenses.
Knowing a company's operating profit and how it relates to other financial metrics is critical for investors, analysts, and entrepreneurs looking to evaluate financial performance, pinpoint areas for improvement, and make well-informed decisions.