Understand Operating Profit – meaning, formula, example, journal entry, accounting, and importance

 

Operating Profit – Definition

Operating Profit is the profit a business earns from its core operations, excluding income from non-operating activities like investments or one-time gains, and before deducting interest and taxes.

Meaning in Simple Words

Operating profit tells you how much money a company makes from its day-to-day business activities after subtracting all operating expenses (like salaries, rent, utilities, raw materials, and depreciation) from revenue.

It does not include any profits from selling assets, interest income, or investments—it’s purely about the business's main operations.

Detailed Explanation

Think of Operating Profit as the financial heartbeat of a company—it shows whether the main business is profitable without considering outside factors.
It is calculated from the company’s income statement and reflects operational efficiency.

• Revenue (Sales): Money earned from selling goods or services.

• Operating Expenses: Costs directly related to running the business (e.g., cost of goods sold, administrative expenses, selling expenses).

• Depreciation & Amortization: Added as part of operating costs.

Formula

$$\text{Operating Profit} = \text{Revenue} - \text{Operating Expenses}$$

Or more specifically:

Operating Profit = Gross Profit − Operating Expenses

$$\text{Operating Profit} = \text{Gross Profit} - \text{Operating Expenses}$$

Example Calculation

A company earns ₹50,00,000 in sales.

• Cost of Goods Sold (COGS): ₹30,00,000

• Operating Expenses (Salaries, Rent, Utilities): ₹10,00,000

$$\text{Gross Profit} = ₹50,00,000 - ₹30,00,000 = ₹20,00,000$$

$$\text{Operating Profit} = ₹20,00,000 - ₹10,00,000 = ₹10,00,000$$

So, the company’s Operating Profit is ₹10,00,000.

Use in Indian Tax & Financial System

• In Indian corporate financial reporting, operating profit is shown in the Profit & Loss account under the Companies Act, 2013.

• For Income Tax, operating profit is part of the calculation for business income before considering interest, depreciation under the Income Tax Act, 1961.

• It’s used in GST compliance to analyse business performance and detect under-reporting of turnover.

• Banks often review operating profit for loan approvals to assess repayment ability.

Why It’s Important

• Measures Core Business Performance – Helps investors see if the main business is profitable.

• Better Comparisons – Excludes one-time or non-operating gains/losses for true performance analysis.

• Decision-Making – Guides management in controlling costs.

• Valuation Metric – Often used in ratios like Operating Profit Margin.

Journal Entry Example

If sales revenue is received:

Bank A/c                   Dr ₹50,00,000  
   To Sales Revenue A/c                     ₹50,00,000  

If expenses are paid:

Salaries Expense A/c       Dr ₹6,00,000  
Rent Expense A/c           Dr ₹4,00,000  
   To Bank A/c                              ₹10,00,000  

Operating profit is derived after posting all expense and revenue entries in the Profit & Loss account.

Accounting Illustration

Profit & Loss Statement (Extract)

Particulars	Amount (₹)
Sales Revenue	50,00,000
Less: COGS	30,00,000
Gross Profit	20,00,000
Less: Operating Expenses	10,00,000
Operating Profit	10,00,000

Legal Implications & Real-World Use Cases

• Company Law: Mandatory disclosure in annual financial statements under Schedule III of the Companies Act.

• Tax Assessment: Used by tax officers to detect manipulation of profits.

• Valuation: Key factor in mergers, acquisitions, and IPO pricing.

• Investor Decisions: Analysts use it to compare operational efficiency across companies.

Related Terms

• Gross Profit
• Net Profit
• EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization)
• EBIT (Earnings Before Interest and Taxes)
• Operating Profit Margin

FAQs

Q1. Is Operating Profit the same as Net Profit?
No. Net profit includes non-operating income and deducts interest & taxes, while operating profit focuses only on core business earnings.

Q2. Does GST apply to Operating Profit?
No. GST is levied on sales, not on profits. However, GST impacts costs and thus indirectly affects operating profit.

Q3. How is Operating Profit Margin calculated?

$$\text{Operating Profit Margin} = \frac{\text{Operating Profit}}{\text{Revenue}} \times 100$$

Q4. Can Operating Profit be negative?
Yes, if operating expenses exceed gross profit.

Expert Tip from Learn with Manika

To improve Operating Profit, focus on reducing unnecessary expenses, improving production efficiency, and increasing sales without proportionally increasing costs.