Difference Between Operating Income and Net Income   

Key Difference – Operating Income vs Net Income
 

Income can be simply referred to as the difference between total fund inflows less total expenses for a business. All companies thrive to make higher profits. Profits can be calculated from the main business activity, after considering all other incomes and expenses. Operating Income and Net Income are two essentially calculated profits in the income statement. The key difference between operating income and net income is that while operating income is the income caused by the conducting business operations, net income is the profit left after considering all the expenditure incurred.

CONTENTS
1. Overview and Key Difference
2. What is Operating Income
3. What is Net Income
4. Side by Side Comparison – Operating Income vs Net Income
5. Summary

What is Operating Income

Operating Income, also frequently called as Operating Profit, is the amount of profit left after covering the expenses incurred from running business operations. These include rent and other utilities, wages and salaries and selling and distribution costs. This profit figure also includes the depreciation for the year, which is a non-cash expense. Operating Income is exclusive of:

• Investment income

Income generated from interest payments, dividends and capital gains collected upon the sale of a security or other assets, and any other profit made through an investing activity.

• Interest payments

Interest payable on debt finance such as loans and bonds

• Tax payments

A financial charged levied by the government

• Taxes and income from secondary operations

Income generated and tax charged on a supplementary business to the core business

Operating Income is also called the ‘Earnings Before Interest and Tax’ (EBIT) due to the exclusion of above elements. Operating Income margin is calculated as per below.

Operating Income Margin = Revenue / Operating Profit *100

Operating Profit margin measures how efficiently the main business activity can be conducted. If the operating profit margin is high, this means that there is a significant amount of revenue available after covering operating expenses.

Return on capital employed (ROCE) is another vital ratio calculated using Operating profit. ROCE is the measure that calculates how much profit the company generates with its capital employed, including both debt and equity. This ratio can be used to evaluate how efficiently the capital base is utilized and is calculated as,

ROCE = Earnings Before Interest and Tax (EBIT) / Capital Employed *100

What is Net Income

Net income is the profit available for company’s shareholders after all the expenses are covered. Thus, it is also referred to as net Earnings or ‘bottom line’. In other words, it is the net increase in shareholder’s equity. Net profit will be used to pay dividends to shareholders or transferred to earnings reserved or both. Net income is derived from deducting all the expenses recorded and including taxes, investment income and interest payments. Net Income margin is calculated as per below.

Net Income Margin = Revenue / Net Profit *100

This ratio indicates the amount of profits available after covering all the operating and non-operating business expenses. Since this is the profit that the shareholders can claim, this is the most vital profit for the business.

Net Income is a very useful aspect as it is used to calculate three main financial ratios. They are,

Earnings Per Share (EPS)

Governed by IAS 33, this is the amount of net income earned per share of stock outstanding and is calculated as per below.

EPS = Net Income / Number of Average Shares Outstanding

Higher the EPS, the better; since it indicates that company is more profitable and the company has more profits to distribute to its shareholders.

Return on Equity (ROE)

ROE expresses how much profit is earned for each unit of shareholder equity; thus, a good ROE is an indication that the company is utilizing shareholder funds efficiently and is calculated as below.

ROE = Net Income / Average Shareholder Equity *100

Return on Assets (ROA)

This ratio is calculated to show the profit made as a proportion of the total assets. Therefore this indicates how efficiently the assets are being used to generate income. ROA is calculated as,

ROA = Net Income /Average Total Assets *100

What is the difference between Operating Income and Net Income?

Summary – Operating Income vs Net Income

The difference between operating income and net income should be clearly distinguished in order to understand the effects one has on the other. Operational efficiency should be increased by minimizing costs and wastage in order to increase the operating income.  There are not many components to be considered between the operating income and net income, but tax is one of the major elements that is uncontrollable in the company. Thus, if the firm can make a reasonable operating income, this becomes a main contributor to earning a favorable net income.

Reference:
1. Boyte-White, Claire. “What is the Difference Between Operating Income and Net Income?” Investopedia. N.p., 28 July 2016. Web. 17 Feb. 2017.
2. “Financial Ratio Analysis | Example.” My Accounting Course. N.p., n.d. Web. 17 Feb. 2017.
3. “Operating Income Definition – AccountingTools.” AccountingTools. N.p., n.d. Web. 17 Feb. 2017.
4. “What is the difference between gross and net income? – Questions & Answers – AccountingTools.” Accounting CPE & Books – AccountingTools. N.p., n.d. Web. 17 Feb. 2017.

Image Courtesy:
1. “IBM’s revenue and net income” (Public Domain) via Commons Wikimedia