In order to maintain a consistent understanding of how your business is performing, calculating and regularly updating your operating profit is essential. Not only does this provide a snapshot of the current profitability of your business, it also allows you to identify opportunities for future growth and improvement. But knowing the benefit of keeping up-to-date operating profit knowledge for your business is just the first step—the next is figuring out how you actually calculate it.
In this article, we’ll uncover everything you need to know about the operating profit formula and how to monitor and update it to understand the factors that may cause it to fluctuate over time.
The operating profit formula explained
The operating profit formula can be used to gain a clear understanding of how much profit a business generates from core operational activities over the course of a month, quarter, or year. In order to determine the operating profit of your business, you need to compile several key data points:
- Gross profit: To determine the gross profit of your business, take the total revenue for the period you’re evaluating—that is, the total amount of money you made from your business activities—and subtract the total cost of goods sold (the amount you spent on materials in order to make those goods available).
- Operating expenses: This is the total value of your overhead, like rent, utilities, payroll, and any other regular expenses you pay in order to keep your business open and running.
- Depreciation and amortization: You also have to take into account how your business assets will change in value over time. Depreciation is how significantly your assets will lose value over the course of a set period of time, while amortization is a means of cutting the costs for your assets over time.
When discussing what data is involved in calculating your operating profit, it’s also important to know what won’t be reflected. Operating profits are sometimes called “earnings before interest and tax,” but this is a misrepresentation—interest and tax are not considered operating expenses, and the operating profit formula does not reflect non-operational income.
How to calculate operating profit
So, now you have a stronger sense of what a business’s operating profit does and does not include—but how do you actually calculate operating profit?
Once you’ve examined your financial records and gathered all the above data points, you’re ready to input them into the operating profit formula and determine the operating profit for your own business. Here’s the full formula:
Gross profit – operating expenses – depreciation and amortization = operating profit
Let’s look at an example of how to calculate operating profit. If your business made $200,000 in gross profit and had $50,000 in operating expenses and $10,000 in depreciation and amortization, the formula would look something like this: $200,000 – $50,000 – $10,000. That would leave you with an operating profit of $140,000.
What you can learn from operating profit
Once you’ve run the calculation for your business and determined your operating profit, you’ll get a clear picture of the profitability and overall financial health of your operation. By taking into account only the essential expenses needed to maintain your everyday operations, you can better understand your business’s success and the relevant factors that relate to it.
Determining your operating profit allows you to better assess your stock value, compare your business with peer companies, and draw the attention of potential investors. The operating profit is not only a helpful snapshot of where your company is currently—it also carries important information about the management, efficiency, demand, and possibly even the future earning potential of your business. A strong operating profit sends a clear message to stakeholders and investors that yours is a stable business with a promising future.
Why do you need to monitor operating profit?
There are a few key reasons why you may want to make use of the operating profit formula and monitor its fluctuations over time. While every business owner’s operation is different, there are two specific incentives that many entrepreneurs find applicable regardless of the industry they work:
- Gauging your company’s performance: Because the operating profit formula cuts out a number of irrelevant numbers that don’t directly relate to the success of your business, but do impact the number you see in the bottom line, many experts see it as a more accurate and meaningful indicator of how well your business is doing. Using this number is also a healthier means of comparing your business against others in your field to see how you stack up against your competitors.
- Communicating performance to investors: If you’re looking for investors to help finance a new project, product, or other kinds of expansion in your business, you’ll need to communicate your current performance so they can be confident they’ll see returns on their investment. Since the operating profit formula is calculated using only the essential information, it gives investors the most direct indication of your business’s standing.
What factors cause operating profit to fluctuate?
A business’s revenue can fluctuate month to month, year to year, or season to season. There are a number of reasons why you may see changes in your operating profit. Some of these fluctuations are known and predictable—perhaps you work in an industry impacted by rates of tourism or holiday shopping spikes, for example. Alternatively, you may experience unpredicted peaks and valleys in your operating profit because of the level of success of a marketing campaign or online engagement, increases in your business expenses, or growth in your staff.
By monitoring your operating profit consistently over time, you’ll be able to develop a stronger understanding of the regular fluctuations your business experiences throughout the year, quickly identify unpredictable ones, and devise a plan of action to keep your business running successfully in either situation.
Find a bank that’s built to support you
When it comes to your business finances, making sure you’re aligned with a bank that knows how to help you plan and prepare for future growth is essential. NorthOne was formed with the intention of supporting small business owners in their unique financial hurdles so they can easily accomplish all the routine tasks that come with entrepreneurship and focus their energy on growth.
When you open your small business banking account with NorthOne, you’ll reap a number of benefits—including easy access to all the data you’ll need to run the operating profit formula for yourself and immediate professional support via chat, email, or phone in case you run into challenges along the way. Visit us online to learn more about how our tools and services can create ease in your business journey.
