Operating Income vs. Net Income: An Overview
Operating income and net income both show the income earned by a company, but the two represent distinctly different ways of expressing a company's earnings. Both metrics have their merits, but also have different deductions and credits involved in their calculations. It's in the analysis of the two numbers that investors can determine where in the process a company began earning a profit or suffering a loss.
Key Takeaways
- Operating income is revenue less any operating expenses, while net income is operating income less any other non-operating expenses, such as interest and taxes.
- Operating income includes expenses such as selling, general & administrative expenses (SG&A), and depreciation and amortization.
- Net income (also called the bottom line) can include additional income like interest income or the sale of assets.
Operating Income
Operating income is a company's profit after deducting operating expenses which are the costs of running the day-to-day operations. Operating income, which is synonymous with operating profit, allows analysts and investors to drill down to see a company's operating performance by stripping out interest and taxes.
Operating expenses include selling, general & administrative expense (SG&A), depreciation and amortization, and other operating expenses. Operating income excludes items such as investments in other firms (non-operating income), taxes, and interest expenses. Also, nonrecurring items such as cash paid for a lawsuit settlement are not included. Operating income is also calculated by subtracting operating expenses from gross profit. Gross profit is total revenue minus costs of goods sold (COGS).
Net Income
Net Income is a company's profits or earnings. Net income is referred to as the bottom line since it sits at the bottom of the income statement and is the income remaining after factoring in all expenses, debts, additional income streams, and operating costs. The bottom line is also referred to as net income on the income statement.
Net income is calculated by netting out items from operating income that include depreciation, interest, taxes, and other expenses. Sometimes, additional income streams add to earnings like interest on investments or proceeds from the sale of assets.
In short, net income is the profit after all expenses have been deducted from revenues. Expenses can include interest on loans, general and administrative costs, income taxes, and operating expenses such as rent, utilities, and payroll.
Operating Income vs. Net Income Example
Below is the 2017 income statement for J.C. Penney as reported on their 10-K annual statement. The highlighted areas include operating income and net income to demonstrate how the figures are calculated.
- Revenue (total net sales) was $12.5 billion. Net sales refer to revenue minus returned merchandise, which is common for retailers.
- Operating income was $116 million and included all the expenses associated with operating for the year including rent, utilities, and payroll.
- Net income (loss in this case) was negative $116 million, which was a loss for the year and is highlighted in pink at the bottom of the statement.
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You'll notice that J.C. Penney earned$116 millionin operating income while earning$12.5 billion in total revenue or net sales. However, after deducting the interest paid on their debt which totaled $325 million, the company's operating income was wiped out. As aresult, net income was a loss of $116 million for the year.
Operating incomeand net incomeboth show income for a company. However,it's important to analyze all areas of their financial statements to determine where acompany is making moneyor losing money as in the case ofJ.C. Penney for 2017.
Operating income and net income are crucial metrics for understanding a company's financial health. Operating income reflects the profitability of a company's core business activities by subtracting operating expenses like SG&A, depreciation, and amortization from revenue. On the other hand, net income, often termed the bottom line, accounts for all expenses, additional income streams, and operating costs after deducting non-operating expenses like interest and taxes from the operating income.
To break it down further:
Operating Income:
- Definition: It's the profit left after deducting operating expenses from revenue, showcasing the company's operational efficiency.
- Calculation: Derived by subtracting operating expenses (SG&A, depreciation, and others) from gross profit (total revenue minus COGS).
- Exclusions: It excludes non-operating items like investments in other firms, taxes, interest expenses, and one-time expenses such as lawsuit settlements.
Net Income:
- Definition: It's the overall profit or earnings left after considering all expenses, debts, additional income streams, and operating costs, including non-operating expenses.
- Calculation: Derived by deducting non-operating expenses (interest, taxes, etc.) from operating income and adding any additional income like interest on investments or asset sale proceeds.
- Scope: Covers all expenses, such as interest on loans, administrative costs, income taxes, operating expenses (rent, utilities, payroll), and any non-operating income.
The J.C. Penney example illustrates this distinction vividly. In 2017, they had $116 million in operating income from their $12.5 billion revenue. However, after accounting for $325 million in interest payments, their operating income was nullified, resulting in a net loss of $116 million.
Analyzing both operating and net income helps investors gauge where a company is generating or losing money. This comprehensive examination aids in understanding a company's financial position beyond just its operational efficiency.
