The operating income for a business is the amount remaining after expenses incurred as a result of business activities are subtracted from revenues. Operating income is a good indicator of how well a business is managed. Investors, lenders and managers often calculate percent change in operating income from one accounting period to the next. This is of interest to stakeholders because a change in the proportion of operating income to revenues tells them whether a firm is becoming more or less efficient in its operations.
The Concept of Operating Income
Operating income is the portion of a company's revenues that remains after the costs of the firm's core operations are deducted from those revenues. In general, these expenses fall into two categories: the cost of goods sold and operating expenses. Operating expenses include sales costs, general costs and administrative expenses. Some specific examples of operating costs include rent, insurance, compensation for sales, management and office personnel, and office expenses.
Because this measure is intended to show how much it actually costs to run the business, it does not include non-operating amounts like payments for legal settlements, investment income, interest paid or income taxes. These items are reported on a company's income statement, but they are listed after the information about operating expenses and income.
The percent change in operating income expresses the amount of increase or decrease in operating income from one accounting period to the next as a proportion, rather than in dollars. For example, if a firm has $176,000 in operating income in the current year and $160,000 in the previous year, this is a 10% increase (+$16,000/$160,000).
Significance of Changes in Operating Income
You can describe operating income as the amount of money generated by a firm's operations that is available to pay non-operating expenses, interest on debt and taxes. What remains at the end of this process is the company's net profit — the "bottom line" on the income statement. When management runs a "tight ship" by controlling operating costs and avoiding waste, you can expect growth in operating income as a percentage of revenues to at least match the percentage growth of those revenues. The amount of operating income and the percent change are thus excellent indicators of management efficiency.
Suppose a business has $4.4 million in sales in the current year compared to $4 million in the previous year. This is a 10% growth in revenue. Operating income is $880,000 for the current year versus $800,000 for the prior year. The percent change in operating income is also 10%. Such a result suggests management is maintaining the efficiency of the business's operations. However, if the operating income grows by only 5%, it is a strong indicator of problems with the firm's operations. Investors and lenders may begin questioning the effectiveness of current management.
Calculating Percent Change in Operating Income
To calculate the percent change in operating income, you will need information from the income statements that cover the current and prior years or other accounting periods. Income statements are available in the company's annual reports, which in turn are usually available on a firm's investor relations website. Quarterly and other interim statements are normally located there as well.
Subtract the operating income for the previous year from that of the current year. Divide the result by the operating income for the prior year and multiply by 100 to convert to a percentage. Note that if the prior year's operating income is greater than that of the current year, the answer will be negative. This reflects a decrease in operating income.
Suppose the Widget Company reports operating income for the current year of $880,000. For the prior year, the figure was $800,000. Subtract $800,000 from $880,000 and you get $80,000. Divide $80,000 by $800,000 and multiply by 100. The Widget Company has a 10% increase in operating income.
- Kim Steele/Photodisc/Getty Images