Operating earnings definition
/What are Operating Earnings?
Operating earnings are the profits remaining after all operating expenses are subtracted from revenues. Operating expenses include the cost of goods sold and selling, general and administrative expenses. These earnings provide the best view into how well a business is performing, since it strips away all other expenses that do not relate to operations, such as financing costs and taxes. Given its importance, outside analysts routinely include operating earnings in their analyses of businesses, including how they compare to other firms within the same industry.
Operating Earnings Best Practices
There are several best practices associated with the use of operating earnings information, which are as follows:
Subdivide earnings information. Given its importance, management may choose to track the operating earnings measurement more precisely, calculating it for each geographic location, brand, and/or product line. Doing so provides insights into where a firm is generating the bulk of its profits. This can result in some of these reporting areas being shut down or sold off, if they do not generate adequate earnings.
Plot on a trend line. Operating earnings can be plotted on a trend line, to determine its variability over time; a high level of variability can be a concern, since it increases the risk of not being able to generate a profit over the long term.
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Problems with Operating Earnings
A business that reports its operating earnings to the investment community may be tempted to emphasize this information, rather than its net income figure (which includes both operating and financing results). An undue emphasis on operating earnings can adversely skew investor perceptions of how well a business is performing. This is usually done when a business is reporting strong operating earnings, but poor net income.
Example of Operating Earnings
Big Widget Company has $1 million of revenue, cost of goods sold of $400,000, and sales, general and administrative expenses of $500,000. Based on this information, its operating earnings are $100,000. This amount may be further reduced by taxes and interest expense, and may be increased by interest income.