Operating Profit: Definition, Formula, and Examples
Operating profit represents a company’s profit after all expenses except for interest expense, taxes, and one-off costs have been deducted.
What is Operating Profit?
Operating profit is the profit a company makes on its primary business functions. It excludes income and expenses from sources that are outside of the day-to-day business operations such as investment income and tax expenses. Operating profit can also be referred to as operating income or Earnings Before Interest & Taxes (EBIT).
What is the Formula for Operating Profit?
The formula for operating profit is:
Operating profit = Gross Profit - Operating Expenses - Depreciation and Amortization Expenses
How Do I Calculate Operating Profit?
Operating profit can be calculated by first calculating gross profit. Gross profit is the revenue from sales minus the cost of goods sold (COGS). From the gross profit figure, subtract operating expenses– those overhead expenses that are incurred in the day-to-day business operations– and depreciation and amortization expenses to arrive at the operating profit.
The following are excluded from the operating profit calculation:
- Investment income from sources outside core business functions
- Interest expense
- Tax expense
- Other one-off income or expense items– ex: lawsuit or insurance payouts
Example of Operating Profit
ABC Company has the following income statement for its most recent fiscal year.
Using the figures from this income statement, you can easily identify the operating profit and calculate the operating profit margin. The operating profit is depicted on the income statement, but it can also be calculated as follows:
$500,000 - $350,000 - $30,000 - $20,000 = $100,000
Where:
- $500,000 = Sales Revenue
- $350,000 = Cost of Goods Sold
- $30,000 = Operating Expenses
- $20,000 = Depreciation & Amortization
- $100,000 = Operating Profit
What Is Operating Profit Margin?
Operating profit margin is a measure of a company’s return on sales. The operating profit margin represents how effective the company is at generating profit from its core business functions. The resulting percentage shows the operating profit generated from every $1 in sales.
The formula for operating profit margin is:
Operating Profit Margin = Operating Profit / Sales Revenue
Example of Operating Profit Margin
ABC Company has the following income statement for its most recent fiscal year.
Using the same figures as the example earlier, the operating profit margin can be calculated by taking the operating profit and dividing it by the sales revenue.
$100,000 / $500,000 = 0.2 = 20%
Where:
- $100,000 = Operating Profit
- $500,000 = Sales Revenue
- 20% = Operating Profit Margin
What Is a Good Operating Profit Margin?
What is considered to be a good operating profit margin varies by industry. Some industries are high operating profit margin industries, while others are low operating profit margin industries. Therefore, it is impossible to compare businesses in different industries when looking at operating profit margins alone. Always compare similar businesses in similar industries.
According to data collected by New York University (NYU) as of January 2023, high operating profit margin industries include:
- Alcoholic beverages
- Computers
- Pharmaceutical drugs
- Software
These industries have operating profit margins between 20% and 50%. On the other hand, low operating profit margin industries include:
- Food wholesalers
- Online retailers
- Grocery retailers
- General retailers
These industries have operating profit margins between 2% and 5%.
Real Company Example: Walmart’s Operating Profit
In Walmart’s Annual Report, Form 10-K for the year ended January 31, 2023, its consolidated income statement reports its operating income– another term for operating profit– to be $20.428 billion in 2023 and $25.942 billion in 2022.
To calculate the operating profit margin for both years, take the operating income and divide it by the total revenues. It is acceptable to include membership and other income because memberships are directly linked to the core business operations of Walmart. From above, total revenues were listed as $611.289 billion in 2023 and $572.754 billion in 2022.
The operating profit margin in 2023 is:
$20.428 billion / $611.289 billion = .0334 = 3.34%
Where:
- $20.428 billion = Operating Income (Operating Profit)
- $611.289 billion = Total Revenues
The operating profit margin in 2022 is:
$25.942 billion / $572.754 billion = .0453 = 4.53%
Where:
- $25.942 billion = Operating Income (Operating Profit)
- $572.754 billion = Total Revenues
Walmart’s operating profit margin dropped from 4.53% to 3.34% over the course of the year from 2022 to 2023. Although its revenues increased from 2022 to 2023, its cost of sales– also referred to as costs of goods sold– increased even more significantly, lowering its operating income. The operating profit margins in both years are in line with what is expected as a major retailer. Both 4.53% and 3.34% are within the expected 2% to 5% for the general retail industry.
What is the Difference Between Gross Profit and Operating Profit?
Gross profit is the profit a company makes after deducting the direct costs associated with manufacturing and selling its goods or services. It is an important profit figure because it represents the direct profit from the production and sale of goods and services.
The formula for gross profit is:
Gross Profit = Sales Revenue - COGS
Operating profit represents a company’s profit after accounting for all the costs of its core business operations. Gross profit differs from operating profit because operating profit deducts operating expenses, depreciation, and amortization while gross profit does not. Operating expenses include overhead items such as sales and marketing, accounting, rent, utilities, and payroll expenses.
What is the Difference Between Operating Profit and Net Income?
Operating profit represents a company’s profit after all expenses except for interest expense, taxes, and one-off costs have been deducted. On the other hand, net income represents the profit after all expenses have been deducted from revenue. Unlike in operating profit, there are no exceptions for net income.
Net income– also commonly referred to as “the bottom line” – is the final profit figure presented on the income statement. Net income represents the profit that remains after accounting for all income and expenses in the period. It includes all sources of income and expenses, even those unrelated to the business’s core operations.
Compared to operating profit, net income also includes income from sources other than the company’s direct line of business. Additionally, net income deducts interest expenses from debt obligations and tax expenses. Net income also includes all one-off income and expense items– such as those from winning or losing a lawsuit settlement or receiving an insurance payout.
Additional Resources
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