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# Operating Income

Step-by-Step Guide to Understanding Operating Income (EBIT)

Last Updated April 12, 2024

## How to Calculate Operating Income?

The operating income of a company, or “operating profit”, is the revenue remaining after deducting operating costs, which comprises cost of goods sold (COGS) and operating expenses (SG&A, R&D).

The operating income metric is important since it only measures the core profitability of a company.

Therefore, the operating profit of a company is unaffected by discretionary management decisions, such as the capital structure, i.e. the mixture of debt and equity used to fund day-to-day operations, and reinvestment activities like capital expenditures (Capex).

• Capital Structure Neutral (i.e. Independent of Financing Decision)
• Neglects One-Time, Non-Operating Costs (e.g. Gains or Losses on Asset Sales)
• Unaffected by Taxes (i.e. Jurisdiction-Dependent)

Since the operating income of a company is capital structure neutral and not impacted by non-operating costs – e.g. interest expense and taxes – the operating profit metric is widely used in corporate valuation.

The operating income calculation is a two-step process:

1. Calculate Gross Profit by Subtracting Cost of Goods Sold (COGS) from Revenue
2. Subtract Operating Expenses from Gross Profit (e.g. SG&A, R&D)

## Operating Income Formula

The formula to calculate a company’s operating income is gross profit subtracted by operating expenses.

Operating Income = Gross Profit  Operating Expenses

Each input of the operating profit formula can be found on the income statement.

• Revenue: Revenue is the “top line” of the income statement and represents the sales generated by a company from selling its products and services to customers, net of any returns, discounts, and sales allowances.
• Cost of Goods Sold (COGS): The direct costs incurred by a company that are directly tied to its efforts to generate revenue.
• Operating Expenses: The indirect costs incurred by a company that are not directly tied to its efforts to generate revenue. Still, the operating expenses are essential to the company’s business model and necessary expenses (e.g. SG&A, R&D).

## What is a Good Operating Income?

In order to track a company’s operating profitability across historical periods or for comparisons to its peer group of companies operating in the same (or an adjacent) industry, it is necessary to standardize the operating profit metric.

The operating margin is the ratio between a company’s operating income and its revenue generated in the corresponding period, expressed as a percentage.

Operating Margin (%) = Operating Income ÷ Revenue

The operating margin varies substantially by industry, so a company’s operating margin must only be compared to its industry peers, which share similar business models, cost structures, and risks.

## Operating Income Calculator

We’ll now move on to a modeling exercise, which you can access by filling out the form below.

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## 1. Income Statement Assumptions

Suppose you’re tasked with calculating the operating income of Apple (NASDAQ: AAPL) in fiscal year 2022 using the following income statement data.

Apple Income Statement (Source: AAPL 10-K Filing)

We’ll start by listing out the relevant inputs to our formula:

• Net Sales = \$394,328 million
• Cost of Sales = \$223,546 million
• Research and Development (R&D) = \$26,251 million
• Selling, General and Administrative (SG&A) = \$25,094 million

## 2. Operating Income Calculation Example

The next step is to calculate Apple’s gross profit by subtracting its cost of sales from its net sales, which comes out to \$170,782 million.

• Gross Profit = \$394,328 million – \$223,546 million = \$170,782 million

In the final step, we’ll subtract Apple’s total operating expenses – R&D and SG&A – from its gross profit.

• Operating Income = \$170,782 million – \$26,251 million – \$25,094 million = \$119,437 million
• Operating Margin (%) = \$119,437 million ÷ \$394,328 million = 30.3%

In closing, Apple’s operating income in fiscal year 2022 is approximately \$119.4 billion, which can be divided by its revenue to arrive at an operating margin of 30.3%.

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