What is operating profit?

Running a business means being familiar with various accounting terms such as operating profit. What is operating profit, and how do you calculate it?

Not to be confused with gross profit or net income, operating profit is a business’s total earnings after paying all related expenses. It’s widely considered to be a clear and accurate measure of a business’s profitability and productivity.

There are certain distinctions that differentiate operating profit from similar accounting, which is why we’ll explore what it means and how to calculate it. We’ll also discuss why it’s important to calculate operating profit, and what it can tell us about a business.

What is operating profit - the basics

In accounting terms, a business’s operating profit is the total earnings from all its core business activities, after paying all business expenses but before tax and interest deductions. The business has no influence on the interest and tax rates it pays, so those expenses aren’t included when calculating operating profit.

Operating profit is generally considered a good success indicator for a business because it only reflects expenses the company can control.

Operating profit vs gross profit vs net income

Operating profit should not be confused with seemingly parallel terms like gross profit and net income. Here’s how they differ:

• Gross profit, like operating profit, takes all income generated by a business and deducts the costs directly associated with the production of goods or the cost of goods sold (COGS). Both accounting terms also exclude taxes and interest. However, gross profit does not include other administrative expenses required to run the business, such as the cost of real estate.
• Net income is the profit earned by a business after deducting the costs of goods sold (COGS) and all other expenses generated in the running of a business, including taxes and interest. Other income streams, such as those from other secondary operations, investments, and once-off earnings from the sale of assets are also factored into net income.

Operating profit sits in the space between gross profit and net income. Operating profit is derived from gross profit once all business costs are deducted, including rent, insurance payroll, utilities, amortisation, and depreciation of assets.

Net profit can be defined simply as the money you get to keep at the end of the day once all deductions are accounted for. It appears at the very bottom of your income statement. 

Is operating profit the same as EBIT?

The difference between operating profit and earnings before interest and taxes, or EBIT, can be a confusing one.

The key thing to remember is that EBIT calculations include other sources of income, non-operating income, and non-operating expenses. These could be dividends and interests gained from investments, or losses caused by lawsuits.

However, if the business doesn’t have other secondary income streams or non-operating revenues, then EBIT and operating profit will be the same.

You may also see larger companies declaring their yearly EBITDA instead of just EBIT. The two extra letters at the end stand for Depreciation and Amortisation, and they only apply to companies that have those costs associated with their operation.

How to calculate operating profit?

Now that we know what operating profit means, how do we calculate it?

The operating profit formula is fairly straightforward once you have all the relevant core company metrics:

You’ll notice that “Operating revenue - COGS” is the formula for finding Gross Profit. If you already know your Gross Profit, you can use that figure directly in the Operating Profit formula.

Additionally, if your business doesn’t have depreciation or amortisation costs, you can leave them out of the equation entirely. All businesses have operating revenues, COGS, and operating expenses, but not everyone has depreciation or amortisation costs.

Example calculation of operating profit

Let’s put the operating formula into practice. For this example, we’ll use figures from tea retailer Ringtons Limited’s income statement from 2023:

• Operating revenue: £80.6m
• COGS: £55.4m
• Operating expenses: £22.4m
• Depreciation: £2.07m
• Amortisation: None reported

Disclaimer: These figures and calculations have been simplified for the purpose of this example. Ringtons Limited’s income statement involves more expenses and other calculations that are beyond the scope of our current topic.

With these numbers in hand, we can calculate the company’s operating profit for 2023:

Operating profit = £80.6m - £55.4m - £22.4m - £2.07m

Operating profit = £0.73m

Quickfire term glossary:

• Operating revenue is the money generated by a company from all its primary business activities, such as selling its products or services. This amount appears in the top line of an income statement.
• COGS means costs of goods sold, which includes any expenses directly involved in producing the company's products or services, such as labour and materials.
• Operating expenses are costs associated with daily business operations, such as wages, staff functions, office supplies, rent, and utilities.
• Depreciation accounts for the value lost over time by any tangible or physical item bought for a business. Cars or computers, for example, will decrease in value in the course of their productive life through wear and tear or changing market conditions. Depreciation measures and allows for this loss, allocating a portion of that cost to be deducted in any given year for tax and accounting purposes. This gives a more accurate view of the item’s value and cost to your business.
• Amortisation is similar to depreciation but covers the cost of intangible assets of value over time. These could be intellectual property, patents, copyrights, trademarks, franchise agreements, and organisational costs.

What is excluded from operating profit?

Operating profit only factors in earnings generated by the business's core functions; in other words all expenses and income associated with its daily operations and the service or goods the business was created to provide

When calculating operating profit, the following earnings and expenses are excluded:

• Tax income
• Interest on debt
• Investment income
• Real estate sales
• Production equipment sales
• Non-recurring expenses such as legal settlements
• Accounting adjustments
• Income earned outside of primary business activities

Excluding these factors from the operating profit helps a business accurately hone in on how profitable its primary business activities are and how efficiently the business is running.  

What does operating profit tell us?

Aside from being a useful way of gauging how well a business is performing, operating profit can also tell us the following:

• It allows anyone with a vested interest in the business to get a sense of how well a company is managed and the overall financial health of the company. These could be the business owners themselves, or lending institutions, potential investors, and stakeholders.
• An operating profit can reveal strengths and weaknesses within the business processes. Once identified, strengths can be built upon and weaknesses addressed. For example, if expenses are deemed excessive, business owners can plan to improve their systems and make the necessary adjustments to minimise costs. It allows management to make informed decisions on what to do going forward regarding costs, future investments, and pricing.
• Once you know your net revenue and operating profit, you can calculate your operating profit margin. This margin is often expressed as a percentage, providing a useful way to measure a business’s growth over time and how well it’s performing against its competitors.

What is operating profit margin?

Operating profit margin is calculated by dividing the operating profit by the net revenue. That number is then multiplied by 100 to get a percentage. It’s a useful way of measuring your business at a glance by reflecting on what percentage of your takings remain after deducting operating expenses.

In general, an operating profit margin of somewhere between 10% and 20% is considered sound, but this differs by industry. For reference, the profitability of UK companies is tracked by the Office of National Statistics, with the latest figures at the time of writing running from April to June 2024. 

Operating profit key takeaways

Understanding operating profit, how it works, how to calculate it, and how to interpret it is key to a successful business. It’s a measure of how well a business is performing.

Unlike gross profit, operating profit allows you to track your business earnings after all costs have been accounted for.

Similarly, while net income includes tax and other non-operating costs, excluding them from operating profit gives you an accurate reflection of the day-to-day profitability of your central business functions.

Operating profit also provides invaluable insight into how to grow your business and maximise its profits going forward. And remember, an important part of any business development is making sure it’s properly covered. Chat with the Howden team about your growing business and all its insurance needs.

Get a quote

Also read:

• Types of business insurance you should know about
• How the autumn budget affects you
• Your guide to setting up a limited company in the UK
• READ MORE OF OUR BUSINESS INSURANCE GUIDES