Operating Profit

Running a business is never easy, and it can be even more challenging when you can’t accurately evaluate your profitability and efficiency. Many companies need more financial visibility, which can restrict strategic decisions regarding pricing, costs, and growth initiatives. This article covers how, by leveraging operating profit analysis, organisations can gain invaluable insights to enhance profitability, optimise operational efficiency, and fuel data-driven decision-making. 

Read on to understand what operating profit entails, how to accurately calculate and interpret it, and why finely tuning this metric can be a game-changer for boosting overall business performance.

Defining operating profit and its value

Operating profit is the amount of money that a company makes after taking out all the costs of running its main business. This means that it doesn’t include things like taxes, interest, or one-time expenses. 

When we look at operating profit, we can see how well a company is doing in its main business activities. It helps us understand if the company is making money from what it does best. 

Operating profit is important because it gives us a detailed look at how well a company performs in areas like sales, production, and administration. By analysing this information, we can see how efficient the company is at making money from its main business activities. Companies can leverage these insights to:

• Understand the real financial health of your business without any confusing accounting issues
• Identify what your business is doing well, what needs improvement, and where there are opportunities for growth
• Use data to set achievable goals and create a plan for success
• Streamline your business processes to make them run smoothly and efficiently
• Compare how your business is doing against others in your industry
• Make it easy for everyone involved with your business to see how well you’re doing financially

These factors underline why both internal and external stakeholders consider operating profit vital for business growth and sustainability.

Calculating operating profit with an illustrative example

The operating profit formula derives this metric as operating revenues minus operating expenses for a specific period. Let’s break this down using an example of a fictional bakery – Cake Walk. 

Operating revenues 

This pertains to the aggregate revenue generated by Cake Walk from its principal business undertakings within the last fiscal year. This comprises the proceeds earned from the following operations:

• Production and sale of cakes and pastries
• Charging of fees for home deliveries
• Earning fees from their loyalty program’s membership

Operating expenses

These cover all the expenses that Cake Walk incurred from its central business functions in the past year. This includes expenses like: 

• Ingredient supplies
• Packaging materials 
• Rent and utilities
• Employee salaries
• Delivery costs 
• Equipment maintenance

Example of operating profit calculation

Consider a bakery company, Cake Walk, with the following financials for 2022:

• Revenue from Product Sales: Rs. 10 Crores 
• Cost of Goods Sold: Rs. 5 Crores
• Selling & Distribution Expenses: Rs. 1 Crore
• Administrative Costs:   Rs. 1 Crore  
• Depreciation: Rs. 50 Lakhs

The operating profit can be calculated as:

Operating Revenues = Rs. 10 Crores

Operating Expenses = Cost of Goods Sold + Selling & Admin Expenses + Depreciation 

                        = Rs. 5 Crores + Rs. 1 Crore + Rs. 1 Crore + Rs. 0.5 Crore

                        = Rs. 7.5 Crores

Operating Profit  = Revenues – Expenses

                   = Rs. 10 Crores – Rs. 7.5 Crores

                   = Rs. 2.5 Crores

So, the company has an Operating Profit of Rs. 2.5 Crores for 2022.

Driving organisational impact through operating profit optimisation 

Focusing on operating profit and profit margin can bring many benefits to an organisation in many ways. Business leaders can use different strategies to achieve this goal:

Review expense management

One way to increase profits for a business is to analyse expenses and find areas where they can reduce waste. For example, let’s say a bakery called Cake Walk can plan its production better, which would help it waste 5% fewer ingredients. This would directly increase their profits.

Boost operational efficiency 

In order to enhance the efficiency of a business, it is crucial to seek ways to achieve more with less. For instance, Cake Walk, a company, can aid in reducing fuel expenses by optimising delivery routes. This can aid businesses in saving money and operating more seamlessly.

Rationalise product/service portfolio

To maximise profits, companies need to figure out which products or services are making the most money. One way to do this is to analyse the profitability of each offering and focus on the ones that contribute the most to the bottom line. 

For example, Cake Walk could put more effort into promoting their popular celebration cakes that people keep buying. By paying close attention to profit drivers like this, businesses can make big improvements in how much money they make, how efficiently they operate, and how they make decisions.

Key differences between operating profit and net profit

While operating profit evaluates core business functioning, net profit encompasses peripheral activities too to give the final bottom line. Key differences include: 

• Net profit accounts for interest expenses that operating profit ignores
• One-time charges like asset write-offs only impact net profit 
• Net profit factors tax expenses, whereas operating profit does not
• Non-operating income like investments only contribute to net profit

Therefore, Net profit showcases the company’s overall health, while operating profit gives us more detailed information about how the company is doing in its day-to-day operations. By looking at these things together, we can better understand how the company is doing as a whole.

Conclusion

It is important to keep track of a company’s operating profit to understand how well it’s doing financially and how efficient it is. This helps to see how much money the company makes from its main activities and where it could improve. By managing operating profit, company leaders can make a big difference to the company’s overall financial health.

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