Definition: Operating profit, sometime called EBIT, is a financial measurement that calculates how much profit a company makes from its core business activities. This figure only includes income from core operations before taxes excluding all income from investments. In this way it is a measure of a firm’s efficiency to control its costs and run its operations effectively.
What Does Operating Profit Mean?
Managers use this calculation to see how well they are doing at controlling costs. Since pricing strategy, labor costs and prices for raw materials affect how profitably a company performs; management has to keep a close eye on these figures. Investors use this measurement to see how competent management is and how efficiently the company is at making money from their core business activities.
The operating profit formula is calculated by subtracting the cost of goods sold, operating expenses, and depreciation & amortization from a firm’s revenues.
Operating profit = Revenues – cost of goods sold – operating expenses – depreciation & amortization
When calculating a firm’s OP, interest expenses, taxes and any income statement item that is not directly related to the firm’s core operations are not included.
Let’s look at an example.
George is a financial analyst with Morgan Stanley and he wants to evaluate how efficient Titian is at making a profit from its operations. The company’s income statement for the year shows:
- Revenues: $2.3B
- Cost of goods sold: $853.4M
- Labor costs $360.0M
- Selling, general & administrative expenses: $120.3M
- Depreciation & amortization: $50M
Thus, George calculates the firm’s OP like this:
$2,300,000,000 – $853,400, 000 – $360,000,000 – $120,300,000 – $50,000,000 = $913,600,000.
So Titian was able to earn $913.6M in profit from its core business activities. Remember this is before any interest is earned from investments and any taxes are paid to the government.
Also, labor costs or other income statement items are different from industry to industry. Therefore, to perform a solid comparison between two or more companies based on their OP requires all companies to trade in the same industry.