Blog

The best content on costs and profitability

The 6 biggest errors in determining operating profit

The 6 biggest errors in determining operating profit

To any company, the need to have indexes that help monitor its actions is critical. Throughout his career, the entrepreneur will have to understand them in order to find out if his measures are measures are on the right track and, mainly, to have no losses in his company’s finances.

Knowing how to properly calculate the operating profit, for example, is a very important factor and can help in this process. Therefore, in this text, we decided to present what are the main mistakes and how to calculate it correctly.

Do you want to know how to proceed? Keep reading!

What is operating profit?

First of all, we need to make clear what operating profit is. It is the gain generated solely by the business’s operation, excluding the administrative, operating and commercial expenses and any other financial activities. It’s important to emphasize that it cannot be confused with gross or net profit, which are steps prior to it, even serving as the basis to calculate it.

The importance of knowing how to correctly calculate the operating profit

A company usually produces a lot of financial data. Most of those are information that is very important for the development of strategies aimed at improving the business.

In this respect, the correct operating profit calculation and, obviously, the use of this tool are an essential artifice to obtain the correct financial control of the company’s revenues.

In addition, this type of operation can help an enterprise understand how its health and efficiency in achieving profitability are. This information is essential to better develop the financial growth goals, or even to realize what needs to be changed in the strategies.

Therefore, we emphasize that, as the operating profit promotes this deep knowledge of the business, the indicator management needs to be done correctly. After all, any wrong data or omission of any information can hinder the company’s next steps in the market.

For example, if the company relies solely on the information obtained from the gross profit, the management might believe that the business is producing more income than is actually being earned.

This is because the gross profit excludes important numbers such as fixed costs (rent, employee salary, etc.); expenses that must be subtracted from the operating profit so that the real gain is presented.

The 6 biggest mistakes in determining the operating profit

Now that you have understood what operating profit is, let’s find out what are the main mistakes made when calculating it. Check it out!

1. Not knowing the difference between operating profit and other profits

Whether it’s through a lack of attention or knowledge, many business leaders don’t know the difference between operating profit and gross and net profits, and this can complicate the proper development of a company and hurt its finances.

So now we’ll explain the differences between these three types of profits.

Gross profit

Gross profit is the result of the subtraction of the production or operating costs from the company’s total revenue. This means that it is the profit that remains after excluding the variable costs – the amounts spent on the production of goods, ranging from raw material to the actual sale. Therefore, it will represent the result of the activity of selling products or services;

Net profit

Net profit takes into consideration not only variable costs but fixed costs as well.

The sum of these costs is the total cost, which will indicate the total of your business expenses.

Therefore, to define your net profit, you need to find the difference between total revenues and total costs.

Operating profit

The operating profit offers relevant information about your business’s current situation.

It is one of the pieces of data that makes up your company’s profit and loss statement, the report that shows what your business results have been for a given period of time, which facilitates your company’s analysis.

2. Not adding operating revenues

In general, operating revenues are related to a company’s main activities. That is, if your business manufactures aircraft turbines, for example, that means the main activity of your enterprise is to build this kind of part.

Thus, the operating revenues will be everything the company earns that is directly related to this manufacturing process, that is, everything that has to do with the business’s main operation.

When we are calculating the operating profit, it is impossible to arrive at the correct result without taking this data into account, given that it is an essential component of the operation, as the operating profit is the gross profit minus the operating expenses plus the operating revenues.

3. Not knowing in what situations, the operating profit should be used

This is one of the most common mistakes; the entrepreneur may even know this kind of profit exists, but has no idea what its actual purpose is, ending up missing the opportunity to improve his business’s results by using effective data that are actually related to the company.

Well, the operating profit must be used to allow the entrepreneur to have a deeper view of his company’s actual operational situation, since the operating profit does not only take into account the production costs, but all costs related to the delivery of the product or service.

In addition, it indicates the earning potential of your business, making it possible for your company to attract more investors interested in its growth.

4. Including taxes

This may be a fairly common mistake, and one that may confuse the result of the operating profit operation.

First, we need to make it clear that, unlike the net profit, which is based on all company costs, whether fixed or not, the operating profit is based on fixed costs. That is, expenses that directly affect the company’s production, such as raw material.

That being said, taxes are not related to the manufacturing process, since regardless of it, they must be paid and, therefore, cannot be part of the operating calculation.

5. Not knowing how to calculate it

Another problem that may arise is the company’s lack of knowledge of how to calculate this measure. To help you, we’ve created a step-by-step guide on how to identify the operating profit. There is no secret to finding it.

You must subtract the gross profit from the operating expenses, and then add the result to the operating revenues. Operating costs are those related to selling, production and administrative expenses.

In turn, the revenues include the gains originated directly from your business’s main activity. By this calculation, it will be possible to measure the capacity to generate profit that your enterprise has.

Given this, we can conclude that the formula is:

operating profit = gross profit + operating revenues – operating expenses

Do you want a more didactic example? Let’s assume that the costs for manufacturing 20 products of your company are $1,000.00. In a given period, $5,000.00 in items was sold and $50.00 was returned, plus $25.00 in discounts. In addition, $1,500.00 was paid in taxes.

If we make the calculations, we will get the following formula for net revenue:

$5,000 – $50.00 – $25.00 – $1,500 = $3,425

Then, to calculate the gross profit, we’ll do as follows:

$3,425 – $1,000 = $2,425

Now that we already have the gross earnings, let’s find out what the operating profit is. Here, we must add gross profit to operating revenues, which are around R$ 750.00, and then subtract operating expenses (employee payments, operating costs, rent, etc.). Let’s assume that these costs are a total of R$ 500.00.

The calculation is as follows: R$ 2,425 + R$ 750 – R$ 500 = R$ 2,675.00.

Thus, we can say that the company’s operating profit is R$ 2,675.00.

6. Not using management software

Technology exists to make many of the financial processes that used to take a long time easier. In that respect, we can include important operations, such as net and operating profits.

In addition to automating this whole process, making it faster, using management software can make data collection easier, collecting information in real time and without the possibility of human errors. That way, it is possible to make calculations to find the operating profit and also produce reports on the performance of your company.

It is now clear that the operating profit is an essential measure to accurately understand the potential of your business, as well as being an important component of the Income Statement.

As we’ve pointed out in previous topics, it is quite different from gross profit, which removes the production or service expenses from the enterprise’s income, while the operating profit informs whether the company is actually profitable, considering the operating expenses.

That way, with the data obtained by this calculation, it is possible to develop more accurate strategies to improve your company’s earnings, since you know exactly how much you are acquiring in your operations.

We hope the information in this article will be very useful for you to understand how to calculate the operating profit. But do not stop there. Keep learning about the business world and strategies you can use to improve your management.

How? Follow our updates on FacebookLinkedIn and Twitter to always be well informed about the best contents on costs and profitability!