When you're starting your own business, there are a lot of financial factors to consider. How much your company is making off your products is more complicated than just adding up the sum of all the items you manage to sell. A big part of your financial bottom line involves understanding the difference between operating income and gross income -- two calculations that should show up on your company's income statement.
If you're having trouble seeing the difference between the two, here's a primer. Gross income represents a company's total revenue, minus the cost of producing your product. If you want to reduce it to a simple formula, it's calculated as: revenue minus cost of goods sold equals gross income.
Also known as gross profit, gross income doesn't include expenses such as salaries, income taxes and office supplies. Gross profit is used to figure out a company's gross margin, which measures how efficiently your company is producing and distributing its products. It's a good way to get a big-picture account of how well your company is using its resources, and how it measures up to other, similar companies in your industry. A high gross margin means you're competing effectively in your industry, while a low gross margin could be a sign that you need to revisit your business model because your costs of production are outpacing sales. Operating income, on the other hand, represents your company's actual profit, after you subtract all of your operating expenses and depreciation (the decrease in value of your company's assets over time).
Operating expenses can include:
- Cost of goods sold (COGS), or the costs your company incurs when manufacturing or selling its products
- Costs incurred from running your business, such as paper, ink, toner, and the cost of heating and cooling your offices
It doesn't include the following:
Although operating income doesn't exactly represent a company's bottom line, it comes pretty close to it. Operating income is used to calculate your company's operating margin, which determines your operating efficiency. As such, operating income is a more accurate representation of a company's profitability than gross income.
- Business Dictionary. "What is gross income?" (Accessed March 23, 2011)http://www.businessdictionary.com/definition/gross-income.html.
- Investopedia. "What Does Operating Income Mean?" (Accessed March 23, 2011)http://www.investopedia.com/terms/o/operatingincome.asp.
- Siciliano, Gene. Finance for the Non-Financial Manager. McGraw-Hill Professional, 2003. http://books.google.com/books?id=dtgZv_h9kSEC&pg=PA60&dq=operating+income&hl=en&ei=YOyJTZ-wJ4ehtwfL0riBDg&sa=X&oi=book_result&ct=result&resnum=8&ved=0CFcQ6AEwBw#v=onepage&q=operating%20income&f=false.