Operating earnings, also known as operating profit or operating income, represent the profit a company makes from its core business operations, excluding the impact of interest payments and taxes. It’s a key measure of a company’s profitability and can provide a clearer picture of the company’s operational efficiency.
Operating earnings are calculated by subtracting the company’s cost of goods sold (COGS), operating expenses, and depreciation from its revenue. The formula is as follows:
Operating Earnings = Revenue – Cost of Goods Sold (COGS) – Operating Expenses – Depreciation
Here’s what each of these elements mean:
- Revenue: The total amount of money a company makes from its business activities before any expenses are deducted.
- Cost of Goods Sold (COGS): The direct costs involved in producing the goods or services sold by the company.
- Operating Expenses: The costs associated with running the company’s core business operations such as rent, utilities, salaries, and marketing expenses.
- Depreciation: The decrease in value of physical assets (like machinery or buildings) over time.
Operating earnings can provide valuable insights into a company’s financial health. If operating earnings are growing, it may indicate that the company is managing its costs and operations effectively. If operating earnings are declining, it could suggest problems with the company’s core business.
Example of Operating Earnings
Let’s assume we have a company called “TechGears Ltd.” that makes and sells electronic devices. Here is a simplified version of its income statement for the fiscal year 2023:
- Revenue: $2,000,000
- Cost of Goods Sold (COGS): $500,000
- Operating Expenses: $300,000
- Depreciation: $50,000
To calculate the operating earnings (or operating profit), we would use the formula I provided earlier. That is:
Operating Earnings = Revenue – COGS – Operating Expenses – Depreciation
Substituting in the values:
Operating Earnings = $2,000,000 (Revenue) – $500,000 (COGS) – $300,000 (Operating Expenses) – $50,000 (Depreciation)
Operating Earnings = $1,150,000
This means that TechGears Ltd. made an operating profit of $1,150,000 in the fiscal year 2023 after accounting for the cost of producing its goods, its operating expenses, and the depreciation of its assets. It doesn’t include any taxes, interest expenses, or other income/expenses not directly related to the core business operations.
Remember, this is a simplified example and real-world corporate finance can be much more complex with many more factors to consider. But the basic principle is as demonstrated.