th images menu user export search eye clock list list2 arrow-left untitled twitter facebook googleplus instagram cross photos entrep-logo-svg

Operating income vs. net income

Knowing the difference between the two terms can help boost your business performance
By Henry Ong |

Q: In a few days, the accounting firm that we have hired will submit the financial statement of the company. How will I know if my business is actually earning? Is it enough that I have a high net income? Are there other indicators I should look at?[question|answer]

A: Reading your company\\\'s income statement your eyes immediately look at the net income as it is a very common profitability indicator because[question|answer] it represents the residual income that the company receives after all the expenses have been accounted for.

But when analyzing your company\\\'s financial performance on a monthly or yearly basis, following movements in your net income is not enough to evaluate its overall earning capacity. This is because the net income reported in your income statement includes income and expenses that are not part of your core operations.

It is possible for a company to report a positive net income despite losing heavily from its core business on a one-time gain on, say, a sale of a piece of property. If you were an investor looking to buy the company and presented with only net income comparisons, you might be deceived into thinking that the company has consistent earnings.

Operating Income
So what should you look for in the income statement other than the net income? You should consider the operating income as the better indicator of your company\\\'s earning power. The operating income is the income that the company realizes from its core business before other items are accounted, as computed below:

Sales – Cost of Sales = Gross Profit – Operating Expenses = Operating Income

Using the operating income margin as an indicator--computed by simply dividing operating income by total sales--will allow you to measure management’s efficiency in running the business. The higher the margin, the more efficient--this means that operating expenses are consciously guarded as sales grow.

The operating income margin also helps you to compare your position against your competitors in the same industry. For example, if you are in the food business, you may compare your margins with the industry average of 25 percent.

Net Income
While operating income captures only items that directly affect the core business operation, the net income captures everything. As an indicator, net income margin will not allow you to accurately compare your business with your competitors, since you may have different capital structures.

For example, you may be financing your business by borrowing money from the bank, while your competitor might be using its own money. Your net income would then be lower than your competitor’s because you are paying interest expense while your competitor has no such expense. Your net income margin will therefore differ greatly, making such comparison difficult. From operating income, the net income is computed as follows:

ADVERTISEMENT - CONTINUE READING BELOW

Operating Income + Other Income – Other Expenses = Pretax Income – Income Tax = Net Income

"Other income" in the equation above includes interest income from money market placements, gain from sale of stock market investments or one-time non-recurring income. This one-time booking may be due to a gain from a sale of properties owned by the company. "Other expenses," on the other hand, include interest expenses on loans, foreign currency exchange losses, investment losses, or loss from sale of capital assets.

If you can distinguish net income and operating income, you will be able to identify opportunities for growth. A debt-laden company may be suffering back-to-back losses not because of declining sales but because of rising interest expenses. Buying out this company might be a good idea, as long as its operating income margin is attractive. This is a good chance to acquire the business at a good price.

Latest Articles

When Duterte Promised New Caliber .45 Pistols for the Military, This PH Arms Maker Fulfilled the Order

But gov't arms procurement needs more reforms to streamline the process, says Armscor Global Defense

byPaul John Caña | February 22, 2018 10:00:00

Which Condos in Metro Manila Have Doubled Their Prices Since Launch?

Leechiu Property Consultants compile data on how selected high-end condominiums have risen in value...

byLorenzo Kyle Subido | February 22, 2018 09:00:00

Amid Dominance of Imports, Why Did Starmobile Start Making Phones in the Philippines?

In an industry dominated by international brands, Starmobile is now one of the largest local...

byLorenzo Kyle Subido | February 22, 2018 09:00:00

I Tried to Build My Business By Doing Favors, But It Got Me Nowhere

If you want people to do something for you in return, you have to make them "pay" for the favor

byLuis Congdon | February 22, 2018 08:00:00

Did You Know You're Losing 10 IQ Points Every Time You're Bombarded With Distractions?

It's worse than if you missed a night's sleep

byAmantha Imber | February 22, 2018 06:00:00

Stop Focusing on 'Right' and Start Building Your 'Right Now'

Here are the ways to know when you should throw 'best practices' out the window and Just. Get....

bySujan Patel | February 22, 2018 02:00:00

4 Tips to Be More Efficient in Your Business

Here's how to stay ahead of your competition

byJonathan Long | February 22, 2018 00:00:00

Only One ASEAN Country’s Mobile Internet is Slower than PH’s. Can You Guess Which?

Mobile internet speed and availability improved in the Philippines last year but still lags behind...

byLorenzo Kyle Subido | February 21, 2018 17:00:00

Fintech Startup Makes Cash-on-Delivery Option Affordable and Convenient for Online Sellers

Payments solutions provider Payo delivers orders and collect cash payments from buyers

byElyssa Christine Lopez | February 21, 2018 14:00:00

Financial Adviser: 5 Food Startup Lessons Every Entrepreneur Can Learn from the Founder of Bibingkinitan

Richard Sanz started out with an iced tea concept before pivoting to the classic Filipino merienda...

byHenry Ong | February 21, 2018 11:00:00

PH Startup Uses AI to Help Businesses Communicate with Customers Better and Faster

Chatbot PH trains and maintains bots for clients in a way that works for their specific needs

byPauline Macaraeg | February 21, 2018 09:00:00

If You Want to Win Over Customers, Appeal to Their Emotions

Shopping data often looks at website visitors through hard numbers, but humans are more driven by...

byLiraz Margalit | February 21, 2018 08:00:00