Profitability is the goal of any business owner. While the idea of selling more than you spend may sound simple, the reality of running a business can be more complex.
That’s because sometimes businesses earn income or have expenses unrelated to what they sell. For example, selling a piece of equipment can generate income, and taxes are an expense—but neither of these is a part of your business model.
So, with all these other activities going on, how do you tell if your core business is profitable? You can use operating profit. But what, exactly, is it? And when should you use it? Let’s find out!
What is Operating Profit?
Operating profit tells if you're making money off your sales before taxes and interest are considered. Also known as operating income, you can find it by subtracting all your expenses (except interest and taxes) from your total sales earnings.
This can help you figure out how much money you’re making from your core business operations, like producing and selling your goods or services. This is especially helpful for business owners who had to take out loans to get their business up and running…Looking at operating profit tells you what business profit would look like without your interest payments.
You may also hear it referred to as Earnings Before Interest and Taxes (EBIT)—but that’s technically incorrect. Here’s why:
Operating Profit vs. EBIT
Earnings before interest and taxes is similar to operating profit, but it’s not exactly the same.
While both require you to subtract all business expenses except interest and taxes, they have different starting points.
Operating profit looks strictly at income from sales revenue, whereas EBIT takes a broader approach and includes any income a business generates in addition to net sales—for example, income from investments or the sale of assets.
So operating profit can tell you more about the profitability of your core business activities, while EBIT shows you the total of how much your business earned during an accounting period before you pay your taxes or interest on loans.
How To Calculate Operating Profit?
Operating profit is calculated as your total revenue minus your cost of goods sold (COGS), operating expenses, depreciation, and amortization.
Operating Profit = Revenue - (COGS + Operating Expenses + Depreciation + Amortization)
Let’s take a closer look at what’s included in each part of the operating profit formula:
- Revenue: Income generated by selling goods and services, also known as operating revenue (doesn’t include non-operating income such as interest income, earnings from investments, or money generated by selling assets or real estate).
- Cost of goods sold: Direct costs of the production of goods or services, such as money you spend on raw materials, labor and storage.
- Operating expenses: Costs needed to keep your business running, such as rent, administrative expenses, insurance, and any costs associated with selling your services or products, such as advertising and commissions.
- Amortization: The cost of an intangible asset, which is expensed over a period of time. For example, if you pay for a trademark, you can’t write off the cost immediately. Instead, you amortize it, reporting a portion of the cost as an expense on the income statement over the next 15 years.
- Depreciation: Allocating the cost of a tangible asset, such as a piece of equipment, over its useful life.
Example of Operating Profit
Now that you understand operating profit, let’s look at an example. Say you own a hardware store, and in the previous month, your revenue and expenses were as follows:
Revenue = $100,000
Cost of Goods Sold (COGS) = $60,000
Operating Expenses = $35,000 total, including
- Payroll = $23,000
- Rent = $6,000
- Utilities = $1,500
- Insurance = $2,000
- Advertising = $2,500
Amortization = $2,000
Interest and Taxes = $1,200
When you plug the values into the formula, you get:
Operating Profit = Revenue - (COGS + Operating Expenses + Depreciation + Amortization)
= $100,000 - ($60,000 + $35,000 + $0 + $2,000)
= $100,000 - $97,000
= $3,000
So, in the previous month, your business generated an operating profit of $3,000.
What Your Operating Profit Tells You
Operating income (or profit) tells you whether your core business activities are making you money or not. Removing non-operating factors, such as debt and income taxes, provides a highly accurate look at your business health.
Here’s how:
When starting a business, one of the things you need to know is whether your business idea is profitable.
However, at the beginning of your journey, you may have to take on loans to get started. Even if you don’t take out loans, initial profits often start small and then grow. The problem is that if your interest payments and income tax expenses are higher than your small initial profits, you might think that your business isn’t making any money.
So, operating profit lets you look at the profit associated with your business model and helps you verify your idea. In other words, it can tell you whether or not the profit loss comes from interest and taxes—or if your business operations simply aren’t generating enough money to cover the costs. One way to keep tabs on your costs? Check out Hourly for pay-as-you-go workers’ comp that’s connected directly to your payroll, so you’re never overpaying on premiums.
To see why calculating profit is a must for verifying your business idea, let’s compare it to two other metrics: gross profit and net profit.
Operating Profit vs. Gross Profit
Gross profit is calculated as revenue minus the cost of goods sold. Gross profit tells you how much money your business makes after taking production costs (costs associated with producing your company’s goods or services) into account—but before subtracting overhead expenses.
If we were to calculate the gross profit using the previous hardware store example, it would look like this:
Gross Profit = Revenue - Cost of Goods Sold
= $100,000 - $60,000
= $40,000
In other words, your hardware store generated a gross profit of $40,000 for the last month. Gross profit is a helpful metric for understanding whether or not your profit margin is high enough to keep your business running. If your selling price isn’t enough to cover the cost of goods sold, you’ll have a negative gross profit.
In this example, both operating and gross profits are positive. However, it’s possible to have a positive gross profit but a negative operating income. If your operating costs, amortization, and depreciation are higher than your gross profit, you end up with a net loss.
For instance, let’s say you spent $7,500 on advertising (which is an operating expense) instead of $2,500. You would still have a $40,000 gross profit, but you would now calculate operating profit as:
Operating Profit = Revenue - (COGS + Operating Expenses* + Depreciation + Amortization)
= $100,000 - ($60,000 + $40,000* + $0 + $2,000)
= $100,000 - $102,000*
= –$2,000
The additional $5,000 worth of operating costs would change your operating profit from $3,000 to an operating loss of $2,000. In this situation, you have a profitable set of products—but you’re spending too much running the business, which is preventing you from making money.
Operating Profit vs. Net Profit
Net profit is the amount of money your business earns during an accounting period once you deduct all expenses from the revenue—including interest and taxes.
The formula for net profit is:
Net Profit = Revenue - (COGS + Operating Expenses + Amortization + Depreciation + Interest + Taxes)
If we plug the information from the hardware store into this formula, we will get:
= $100,000 - ($60,000 + $35,000 + $2,000 + $1,200)
= $100,000 - $98,200
= $1,800
So, your hardware store made a net profit of $1,800 in the previous month. This figure is calculated at the bottom of your company’s income statement and is also known as the bottom line. It represents your net income, which is the actual amount of money you earned during the accounting period.
It’s possible to have a positive operating income and a negative net profit—especially if you have high debt.
For instance, let’s say you have $5,000 more in your interest expenses, making your total non-operating expenses $6,200. Here’s what your net profit calculation looks like:
Net profit = Revenue - (COGS + Operating Expenses + Amortization + Depreciation + Interest* + Taxes)
= $100,000 - ($60,000 + $35,000 + $2,000 + $1,200+ $5,000*)
= $100,000 - $103,200*
= –$3,200
In that case, you would still have an operating income of $3,000, but you would report a net loss of $3,200 after making tax and interest payments.
That means you have a profitable business model, but your debts are preventing you from turning a profit.
In this case, you can reduce your monthly interest expenses by refinancing your loan. Or, you can increase your operating income by raising prices or finding opportunities to reduce your production costs and administrative expenses until your loans are paid off.
What is Operating Profit Margin?
Your operating profit margin will tell you how much profit you make for each dollar of revenue you earn. It also tells you how much money you have left over after operating costs are covered.
In other words, it’s the portion of your sales that you have available to pay for interest and taxes. If you have a higher profit margin, your business is in a better position to pay off debt and cover income taxes without losing money.
Once you know how to calculate operating income, finding your operating profit margin is pretty simple; all you have to do is divide your operating profit by your revenue.
As a formula, it looks like this:
Operating Profit Margin = Operating Profit / Revenue
Let’s take a look at calculating the operating profit margin in action:
Calculation
Using the numbers from the hardware store example, you would calculate your operating profit margin like this:
= $3,000 / $100,000
= .03
So, for every dollar of revenue, you earn an operating profit of 3 cents (or .03 of a dollar).
In this instance, you have 3% of your revenue available to pay for interest and taxes.
Analyzing Your Company’s Profitability
Operating profit is an excellent metric to determine whether or not your core business activities are profitable. It’s especially important when you’re starting a new business and want to see if your business model can make money.
Interest payment and income tax expenses often cover up small profits of new business, so it’s important to keep track of your operating profit too. Now that you know how to calculate this important financial metric, all that’s left to do is plug in the numbers and see how well your business is doing.
1. Introducing Yourself
Your introductory email needs to pack a lot of information into a small package. Try something like this:
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Hello Jane,
My name is John Doe and I work for ABC Agency, where we provide business insurance policies to many of Dallas' rockstar small businesses.
Congratulations on your new business, Jane's Bakery. Are you wondering if you have all the insurance you need? Or if your policies will really cover you in a pinch?
At ABC Agency, we pride ourselves on providing robust, comprehensive coverage options to companies like yours with flexible, pay-as-you-go plans.
Are you available this week to talk more about how we can help? I can help you find the most affordable rates and the best policies out there.
I look forward to speaking with you soon.
Cheers,
John Doe
2. Presenting a Quote
Once you've met with your potential client, a quick reply with their quote will get the ball rolling.
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Hi Jane,
Thanks so much for meeting with me this morning. I loved touring Jane's Bakery–I can still smell those delicious chocolate chip cookies baking! You have a great location, and I'm sure you're going to do great on Front St.
After reviewing my notes, I've pulled together an insurance quote for you (attached). I recommend a business owner's policy. A BOP includes several insurance products in one: liability, property insurance, and business interruption insurance. It offers robust coverage at a competitive price.
I'll call you in a few days to see what you think about this insurance plan. In the meantime, if you have any questions, don't hesitate to email me or call me at [phone number].
Again, thank you for your time today. I look forward to working with you in the future.
Cheers,
John Doe
3. Thanks for Purchasing a Policy
Gratitude is important! It's never a bad idea to thank your clients for their business.
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Hi Jane,
Thank you for choosing a business owner's policy with ABC Agency. We know it's so important to get the right coverage for your business, and we are honoured you've placed your trust in us.
We're excited to work closely with you, and our no. 1 goal is to make sure you're business is always protected.
Do you have any questions? We are here to help. Reach out whenever something comes to mind.
Thank you again for choosing ABC Agency to insure Jane's Bakery.
Cheers,
John Doe
4. Welcome Email
A welcome email helps clients feel like you're there to help–and can softly pitch other insurance products you offer.
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Dear Jane,
Welcome to the ABC family! We are thrilled to have you as a new customer and can't wait to meet all of your insurance needs.
As an independent insurance agency, we work with multiple insurance providers to find the best coverage options for all our customers. If you need any other type of insurance–like [include additional offerings unique to your agency, like life insurance, health insurance, home insurance or anything else]–we can help you too.
Do you want to discuss any of these policies?
Cheers,
John Doe
5. Introducing a New Product
A happy client may want to expand their business with you.
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Hello Jane,
I hope all is well with you and Jane's Bakery. I stopped in yesterday for a blueberry muffin and coffee, and they were delicious. I loved the hint of cinnamon in the muffin! Was that your idea?
I wanted you to be the first to know we are now offering commercial vehicle insurance to our policyholders. Auto insurance for your catering vans is super important since your personal car insurance won't cover them.
We're offering this insurance coverage solely to our current business clients at the moment and have some very competitive rates.
Would you like me to work up a quote for you?
As always, thanks so much for being a part of the ABC family.
Cheers,
John Doe
6. Asking For Referrals
Once your relationship is established and comfortable, let your clients help you grow.
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Hi Jane,
You've been a valuable member of the ABC family for two years now, and we so appreciate your business–not to mention the muffins you supply for our monthly meetings!
Because you are a valued policyholder, I wanted to ask a quick favour. I know you are active in the local Chamber of Commerce, and I'm hoping you might know some colleagues who would benefit from working with our insurance company.
Referrals are one of the most effective ways to connect with our community since people really trust their friends, family and colleagues. Is there anyone you'd recommend I speak with?
Remember that in addition to business insurance products, we offer everything from life insurance policies to pet insurance.
As a thank you for your help, we will send you an Amazon gift card of $100 when your referrals buy insurance from us.
Thanks so much for your help!
Cheers,
John Doe
7. Policy Renewal
If your client needs to renew their policy with you, send an email like this:
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Hi Jane,
I hope you're doing well! What a year it's been—from being listed as one of the top 5 bakeries in Dallas to being an official vendor for the city—you have so much to be proud of.
Just a heads up that your business owner's policy is up for renewal soon and will expire on June 15, 2023.
If you're still happy with the coverage, we can easily renew it for you.
Do you have some time to chat this week?
Looking forward to serving you again!
Cheers,
John Doe