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Understanding the financial health of a business isn’t just about looking at the cash flow—it’s about dissecting each aspect of the financial statements to get all of the most detailed insights to make the most informed decisions. Today, we’re here to unscramble the often-confused terms in the world of finance: operating income vs. net income.

Operating Income Vs. Net Income: Differences, Definitions & Calculations

Both metrics matter, but distinguishing them is essential for evaluating business performance and profitability. This article is meant to lead you through the maze of numbers so you have clarity and confidence in interpreting these financial indicators.

Definitions of Operating Income vs. Net Income

To set the stage, revisiting the definitions we provide in the Xledger Accounting Glossary is helpful. There, we explain that operating income is “the adjusted revenue of a company once all necessary expenses and depreciations are accounted for and subtracted from the total, specifically those related to the costs necessary to keep the business running.”  

For defining net income, AKA net profit, we use this example: “Net profit is how many sold fish become pure profit against how many sold fish go into expenses. Giant nets yield more significant net profit, as they can catch more fish.” 

Right off the bat, operating income vs. net income has some key differences. 

Here’s another way to look at these differences. 

So, if operating income is what a business earns from its core operations, with all necessary expenses subtracted—you can imagine it as the profit yielded from the operations that are the bread and butter of a company. 

On the other hand, net income, or net profit, encompasses the entire fishing expedition. It tallies up every sold fish, whether from the day’s catch (operations) or an unanticipated treasure chest (non-operating activities).

Understanding the Differences: Fixed vs. Variable Costs

The crux of the difference between operating and net income lies in how each deals with costs. 

Operating income focuses on expenses directly tied to the day-to-day running of the business—also known as operating expenses. 

Think: 

• Salaries
• Rent
• Utilities

In contrast, on top of the operating costs it includes, net income also takes into account any additional, often variable, expenses or incomes from outside the usual business activities. This means any cost or profit that doesn’t come from the main operational activities of the company affects net income but not operating income.

Some variable costs that can impact net income include:

• One-time legal fees
• Investment income
• Gain or loss on the sale of assets
• Interest expenses
• Taxes

Calculating Operating and Net Income

Understanding what these terms mean is one thing, but knowing how to calculate them matters, too. Fortunately, accounting and financial software like Xledger takes the guesswork out of this. Still, it’s helpful to know what’s going on behind the scenes.

As you’ll see, the formulas themselves might not be complex. But knowing exactly what to include in each equation can be more of a puzzle.

Calculating Operating Income

To calculate operating income, you start with gross profit—the difference between revenue and cost of goods sold (COGS). From there, subtract all operating expenses to determine your final operating income.

Most simply, the formula looks like this:

Operating Income = Gross Revenue – Operating Expenses

Example

If a company’s gross revenue from selling bespoke teapots is $1,000,000 and its operating expenses total $600,000, the operating income is $400,000.

Dive deeper into operating income calculation here: What is Operating Income? A Guide to Calculation and Reporting.

Calculating Net Income

On the other hand, calculating net income is a bit more complex. You begin with operating income and then add or subtract any non-operating activities. This includes interest expenses, taxes, and other one-time costs or gains. The final number is your net income.

In this case, the formula would be: 

Net Income = Operating Income + Non-Operating Revenues – Non-Operating Expenses

Example

Imagine the same company also made $50,000 from investments (non-operational activity) but had to pay a $30,000 loan interest. Thus, its net income becomes $420,000 ($400,000 operating income + $50,000 – $30,000).

A Note on the Impact of Non-Operational Activities on Net Income

Non-operational activities, like investments, property sales, or lawsuits, can significantly affect net income. These activities often bring unpredictability to the profitability equation, underscoring the importance of net income for a comprehensive view. 

However, note that some companies may have consistent non-operational activities. In this case, analysts may adjust their evaluation of a company’s performance to exclude these activities and focus solely on operating income. It ultimately depends on the industry and company in question.

Why Operating Income Matters for Business Performance Evaluation

Operating income gives stakeholders a clear view of profitability stemming directly from core business operations, setting aside any external factors. It’s a stark, undiluted measure of operational efficiency and the success of a company’s primary business model. 

Operating income is a solid metric to use when you need to provide an accurate picture of a company’s financial health. It allows you to assess how profitable the organization is solely based on its primary activities without factoring in non-operating items that may skew the numbers.

An added benefit of the metric is that it can also provide insights into areas where cost-cutting measures could be implemented or where efficiency can be improved. 

How Net Income Assesses Profitability

We know that net income reveals the comprehensive narrative of a company’s financial well-being—it includes all sources of revenue, not just those from the main business operations but also from secondary sources like investments and interest. 

Similarly, it accounts for all costs, including operating expenses, taxes, and interest payments. 

All of this culminates in reflecting the actual bottom line, which indicates what is truly realized as profit. In turn, it gives stakeholders a far more holistic view of the company’s financial performance.

When to Use Operating Income vs. Net Income

Operating income can help you understand the operational efficiency and performance of core business activities. Net income should be your go-to when assessing the company’s overall profitability and financial health, including external factors.

Real-World Applications for Each Metric

To better illustrate the difference between these two performance metrics, let’s take a look at some real-world applications of both. 

• Retail

We’ll start with a retail company.

Operating income may be more useful for such a company in determining its sales strategies and cost management effectiveness. 

On the other hand, net income offers better insights into the overall financial viability of the company, taking into account factors like investments and interest income. 

• Tech

Now, let’s look at a tech industry example.

In this case, operating income may be more relevant to analyze a company’s research and development efforts. 

Meanwhile, net income would give a better picture of the company’s overall profitability since it accounts for factors such as patent licensing or investments in other companies.

• Manufacturing

Let’s use a manufacturing company that produces automotive parts for this example. 

Operating income would be valuable in this scenario for assessing the efficiency of the production process and the cost-effectiveness of manufacturing operations. 

Because it analyzes operating income, the company can then evaluate its ability to:

• Control production costs
• Optimize manufacturing processes
• Generate profits from core business activities

For the net income scenario, let’s say the manufacturing company generates additional income from investments in other industries or realizes gains from the sale of surplus assets. Then, net income would reflect the company’s overall profitability because it considers all sources of income and expenses.

Operating Income Vs. Net Income: FAQs

Refer to these FAQs for quick refreshers on operating income vs. net income.

Are Net Income and Operating Income the Same Thing?

No, they encompass different areas of a business’s finances—operating income measures core business profitability, while net income includes all revenue and costs.

What Is Included in Operating Income?

Operating income, also known as operating profit, encompasses all revenue and expenses directly associated with the core business operations of a company. 

This includes sales revenue, COGS, and operational expenses such as salaries, rent, and utilities. In terms of its exclusions, these include non-operating income and expenses like interest payments or income from investments. 

Businesses use this metric to demonstrate their financial health (or lack thereof), as it reflects their ability to generate profit from their primary business activities.

Can Net Income Be Higher than Operating Income?

Yes, if a company has substantial non-operational income that exceeds its non-operational expenses, net income will be higher than operating income. 

Another common scenario is when a business has financial leverage, using debt to finance its operations. In this case, the interest expense will reduce net income but not operating income.

What Is the Formula for Net Income?

Net Income = Operating Income + Non-Operating Revenues – Non-Operating Expenses

How Do You Calculate Operating Income?

Operating Income = Gross Revenue – Operating Expenses

What’s Next?

Ultimately, the keen insights offered by these financial measurements are indispensable for steering any business toward success. This isn’t an either-or situation—both operating income and net income play starring roles in assessing and improving a company’s financial health. 

And remember, tools like Xledger can automate up to 75% of accounting and financial tasks, freeing you to focus on these strategic evaluations. Curious to see how it works? Book a demo today and discover how we can help transform your business.

Did You Learn a Lot about Operating Income vs. Net Income in This Article?come vs. net income in this article?

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