What is Operating Profit?

Are you confused about operating profit and its importance to your small business?

If the answer is yes, then you’ve come to the right place! Operating profit can provide critical insights into your business’s success over a specified period. In this blog post, we will explain in detail what operating profit is and how it helps inform decisions that should help make your business more profitable overall.

This way, you can ensure that your hard work pays off and build a sustainable future confidently.

Operating Profit Definition

Operating profit, also known as earnings before interest and taxes (EBIT), measures a company’s profitability, excluding non-operating expenses such as interest, taxes, and other extraordinary items. In other words, it’s how much your business has made after all operational costs have been taken out.

Operating Profit Formula

To calculate operating profit, there is a formula – subtracting operational expenses, such as the cost of goods sold and administrative costs, from total revenue. There is a simple formula:

Operating Profit = Gross Profit – Operating expenses

The best way to find the operating profit of a business is by using accounting software like QuickBooks or Xero.

Why Is Operating Profit Figure Important?

Operating profit tells you how much your business makes from its core operations. It measures how much money you have left after taking out all costs associated with operating the business. It can be used to make important decisions about expanding the business, investing in new equipment, or hiring more staff.

It’s also an indication of your business’s overall health and provides essential insights into how well or poorly you are performing. Knowing your operating profit can help you decide whether to cut costs, increase sales, or make other changes to maximise profits and ensure a healthier bottom line.

Understanding and using operating profits is essential for running a successful small business.

Gross Profit

Gross profit is an important metric used to measure the success of any business. It is calculated by taking the gross revenue or operating income and subtracting all associated costs for production and the cost of goods sold.

An example is a business resells a computer. It brought it for 500 and sold it for 750. The gross profit is, therefore, 750 – 500 = 250.

Another example is a business that makes widgets. The Gross profit is the widget sales minus the costs and related expenses of production. Production might include labour and rent.

What are Operating Expenses?

It’s vital to understand operating expenses when running a business. Operating expenses also referred to as operating costs, are the costs associated with operating your business, such as administrative expenses, insurance, depreciation and office supplies.

These operating expenses appear on the profit and loss statement for any period, whether monthly, quarterly or annually. Understanding operating expenses is vital in understanding how your company performs financially and where changes can be made to increase profitability or reduce operating expenses.

What are Non-Operating Expenses?

Non-operating expenses are those that do not relate to the day-to-day operations of a business. They may include, but are not limited to:

• Sales of assets
• Interest payments
• Taxes
• Costs of merging, expanding or purchasing a business
• Other extraordinary items.

The non-operating expenses appear at the bottom of the profit and loss statement for any period and are excluded from operating profit calculations. After the non-operating has been taken into account, it will give the net Profit figure.

What is the Operating Profit Margin

The company’s operating profit margin measures the percentage of revenue left after subtracting all operating expenses. It is calculated by dividing operating profit by net sales and multiplying by 100. An example is shown further down.

This calculation provides valuable insights into how well a business performs and whether or not it is utilising its resources efficiently. A higher operating profit margin indicates the company is more profitable, whereas a lower profit margin suggests room for improvement.

Understanding and calculating operating profit margins can be invaluable for managing and growing a business. It provides insight into where changes can be made to maximise profits and identifies areas of potential cost savings.

How to Increase Operating Profit

Increasing operating profit requires careful analysis, strategic planning, and sound decision-making. Businesses must first identify areas of potential cost savings. There are several ways to increase operating profit.

Increase sales by increasing prices, running a marketing campaign or offering a discount.

Reducing overhead costs such as purchasing cheaper stock or reducing rent, energy consumption, and personnel expenses.

Companies can also increase profits by increasing operational efficiency through streamlining processes and improving customer service.

Understanding and utilising operating profit is essential for running a successful small business. Calculating gross profit, operating expenses, non-operating expenses and operating profit margin helps managers identify areas of improvement in costs and revenues,

Gross Profit vs Operating Profit vs Net Profit

When it comes to financial calculations, you may encounter three terms: gross profit, operating profit, and net profit.

Gross profit is the difference between a company’s revenue and the cost of goods sold; essentially, it’s what’s left over from sales after product costs have been deducted.

Operating profit is a company’s income minus operating expenses such as administration costs, rent, insurance, and employee salaries.

Finally, net profit is the total amount of money left over after deducting all expenses, including non-operational costs such as interest and dividends, from all revenues.

All three determine how much a business has made and in what form that money is earmarked for potential future use.

Operating Profit Example

Below is an example income statement from a manufacturing business.

The above example shows an operating profit of 33,312 and a net profit of 27,062 after other income and taxes are taken off.

The operating profit margin is:

Operating profit / net sales revenue = 33,312 / 125,248 = 0.25

0.25 = 25% operating profit margin.

What is Operating Profit? Conclusion

In conclusion, when answering the question of what operating profit is, it is important to understand the different types of profit when running a successful small business.

Gross Profit measures success and can be calculated by taking gross revenue or income and subtracting all associated costs for production and cost of goods sold.

Operating Expenses are the costs associated with operating your business, such as administration, insurance, office supplies, etc. In contrast, Non-Operating expenses are not related to a business’s day-to-day operations.

Lastly, the Operating Profit Margin measures the percentage of revenue left after deducting all operating expenses. Understanding these terms will help you know how well your company performs financially and where changes can be made to increase profitability or reduce operating expenses to maximise profits.