What are Operating Earnings?

Malcolm Tatum

Operating earnings refers to the amount of revenue generated by the sales of goods or services, less any applicable operating expenses, but before deducting any taxes due, depreciation on assets, or interest paid on outstanding debt. The calculation of this type of earnings is considered crucial to properly assessing the efficiency and value of the core business of the company. This is because the calculation of operating earnings focuses specifically on the relationship between the sales generated, the costs of goods and the manufacturing of those goods, and how efficiently the business is managing the earnings process at the current level of production.

Man climbing a rope
Man climbing a rope

The exclusion of other forms of income from operating earnings makes it much easier to obtain an accurate picture of the essential operation. Including any earnings or income from other sources would tend to skew the resulting figures, making it appear that the earnings on the products produced were higher than they actually were. For example, if a company sold a tract of land, the proceeds from that sale would not be included in the calculation of operating earnings, since the sale was not directly related to the production and sale of the company’s products.

Taxes are also not included in the calculation of operating earnings. In fact, many people refer to this type of earnings as earnings before interest and taxes, or EBIT. The idea is that not including certain expenses or types of income preserves the relationship between the actual cost of producing products and the amount of income that is generated as a result of the production. Assuming that the amount of earnings consistently exceeds the costs of production from one economic period to the next, investors are likely to see the company as a viable investment, either in the short-term or the long-term.

There are several expenses that are deducted as part of the process of calculating operating earnings. Expenses related to the upkeep of machinery used in the production process are a common deduction. In like manner, the cost of raw materials is also considered when figuring the operating earnings for a specific time period. Essential administration costs are also subtracted from the revenue generated by the sale of finished goods, along with any expenses directly connected with the marketing and sales efforts employed to generate those sales.

Operating earnings essentially represent true operating profit, or the amount remaining after all the costs incurred in the process of creating and selling products has been settled in full. In many nations, accurately determining the amount of income tax owed by the company depends on identifying this figure. Since this figure is much lower than the actual gross revenue generated by the business, it is to the company’s advantage to accurately determine operating earnings, and report them using the procedures set in place by the relevant tax agencies.

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