What is the difference between operating income and EBIT?
Operating income is a good indicator of how well a company is performing and how good the management is. See what it is, how to calculate it and why it matters.
Operating income is a good indicator of how well a company is performing and how good the management is. See what it is, how to calculate it and why it matters.
What is operating income?
Operating income, also known as operating profit, is one way for companies to measure how profitable they are based on their operational performance.
Essentially, it’s the income or profit from the goods and services a company provides once the costs of operating the business and other running costs are subtracted.
The basic formula for operating income is:
Total revenue – operating expenses = operating income
It’s just one useful way of measuring operational profitability at a very top level. Check out our guide to revenue vs income to help you understand profitability.
Why is it important to understand operating income?
Getting to grips with operating income can be useful if you run a business or want to invest in one, because it helps show whether a company is being managed properly and cost-effectively.
Operating profit can make it easy to compare a business with similar companies in the same industry, revealing how a good a company’s operational efficiency is against its competitors.
It can also help inform:
- Pricing strategy for goods and services
- How much to pay for raw materials
- Decisions on wages and other labour outgoings.
However, operating income doesn’t take into account some of the other factors that may affect the overall profitability of a company: for example, one-off costs and gains from, say, selling a subsidiary or making redundancy payments.
There are other metrics that can also be used to analyse profitability, such as EBIT.
What is EBIT?
EBIT stands for earnings before interest and taxes. It’s similar to operating profit but, although the terms are sometimes used interchangeably, it takes into account different things.
EBIT includes interest income and other income that wouldn’t be included in operating profit. It can also help with comparing the cost of debt if you look at it alongside operating income. This can make EBIT helpful if you want to compare the profitability of two similar companies, one of which has debt while the other doesn't.
The formula for EBIT is:
EBIT = net income + interest + tax
What is EBITDA?
As well as income and tax, EBITDA includes depreciation and amortization. These are ways to account for the cost of physical assets – for example, machinery and equipment – over their useful lifetime.
What are the key differences between operating income and EBIT?
Operating income and EBIT capture different elements. How useful they are to you will depend on how important these elements are for your understanding of the finances of a business.
- EBIT takes into account income not related to a company’s core business – dividend income, for example – while operating income does not.
- EBIT ignores how much debt is costing the business, while operating income deducts interest costs from revenue as a business expense. This means you can see net income without the cost of debt, which can be useful for comparing companies with or without debt.
- EBIT doesn’t take tax into account, which may have a significant impact on overall profitability. For example, if a company had to pay a windfall tax.
Operating profit gives a clear indication of how much profit the core business is generating.
EBIT could more easily be inflated or decreased by a one-off gain or loss, but can give a clearer idea of the company’s profitability as a whole for the particular time period in question.
Operating income example
A company makes furniture. They total up all their operating expenses, including how much it costs to make the furniture, their rent and other bills, their tax, interest on a loan for machinery and what they’ve earned from the furniture they’ve sold.
For the year, their simplified accounts are as follows:
| Total revenue | £25m |
|
Operating expenses
|
£15m |
| Operating income | £10m |
EBIT example
In this example, although the figures are the same, the elements of operating expenses taken into account for EBIT are giving a higher total.
| Total revenue | £25m |
Operating expenses
|
£15m |
| Operating income | £10m |
| Tax bill | £1m |
| Interest expenses | £0.5m |
| EBIT | £10m + £1m + £0.5m = £11.5m |
Frequently asked questions
What operating expenses are included in operating costs?
Operating costs should include everything it takes to run a business. This could include:
- Rent for premises
- Salaries
- Utility bills
- Business insurance
- Money for research and development (R&D)
- Sales and marketing costs
- Admin costs
- Raw materials
- Machinery.
What is the cost of goods sold (COGS)?
This is one of the elements included in a business’s operating costs. It derives from the direct cost of producing goods sold, including the raw materials and the labour required to make the goods. It doesn’t include other costs, such as distribution costs and marketing.
What is depreciation?
Depreciation is the way an asset can be valued over the course of its lifetime. It’s used for assets whose value becomes less over time – for example, if a business buys an expensive piece of machinery, its value will typically go down as it gets used.
Accountants calculate depreciation in different ways: for example, to work out the useful life of a piece of equipment, or its salvage or second-hand value. It’s a complex area – so if you need to work out depreciation, talk to an expert on that subject.
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