What Are Operating Earnings?

What Are Operating Earnings?

Let me explain operating earnings to you directly: it's a key term in corporate finance and accounting that focuses on the profits from a business's main operations. You calculate it by taking revenues and subtracting the expenses directly tied to running the business, like cost of goods sold (COGS), general and administrative (G&A) expenses, selling and marketing costs, research and development, depreciation, and other operating costs.

You should know that operating earnings are crucial for measuring corporate profitability. Since this metric leaves out non-operating expenses such as interest payments and taxes, it lets you evaluate how well the company's primary business lines are performing.

Understanding Operating Earnings

Operating earnings are central to both internal and external analysis of how a company generates and how much money it makes. You can measure individual components of operating costs against total operating costs or revenues to help management run the company effectively.

You'll typically find operating earnings in a company's financial statements, specifically near the end of the income statement. It's close to the bottom line but not quite—it doesn't account for everything. The true bottom line is net income, which is what's left after deducting taxes, debt repayments, interest charges, and other non-operating items.

Tip

Remember, operating earnings can be used interchangeably with terms like operating income, operating profit, and earnings before interest and taxes (EBIT).

Operating Earnings vs. Operating Margin

There are many metrics derived from operating earnings that you can use to compare a company's profitability with its peers. One key one is the operating margin, which management and investors track closely quarter to quarter to spot profitability trends.

Operating margin is expressed as a percentage and calculated by dividing operating earnings by total revenues. The formula is straightforward: Operating Margin = Operating Earnings / Revenue.

Management uses this to evaluate the profitability of business decisions over time. Lenders and investors watch it because it shows how much revenue remains to cover non-operating costs like interest on debt.

If operating margins vary a lot, that's a sign of business risk. Looking at past margins and trends helps you gauge if a big earnings increase will stick.

Example of Operating Earnings

Let's look at an example: Suppose Gadget Co. has $10 million in revenues in a quarter, $5 million in operating expenses, $1 million in interest expense, and $2 million in taxes. Their operating earnings would be $5 million—that's $10 million revenue minus $5 million operating expenses. The operating margin is 50%, calculated as $5 million operating earnings divided by $10 million revenue.

To get net income, you subtract interest expenses and taxes, and adjust for any one-time gains or losses from the operating earnings. For Gadget Co., net income comes out to $2 million.

Special Considerations

Sometimes companies present a non-GAAP 'adjusted' operating earnings figure to account for one-off costs that management doesn't see as part of regular operations.

Non-GAAP earnings are an alternative to the Generally Accepted Accounting Principles (GAAP) that U.S. firms must use in financial statements. Many companies report both GAAP and non-GAAP earnings.

For instance, expenses from restructuring— which involves major changes to debt, operations, or organization to limit harm and improve the business—might be added back to show higher adjusted operating earnings. But critics argue that if these costs happen regularly, they shouldn't be treated as one-offs.