Operating income is the income reported in the income statement of the company before taking account of the interest and taxation. In accounting and finance, this operating income is also known as earnings before interest and tax (EBIT) or profit before interest and tax (PBIT). After this income is calculated, interest and taxes are subtracted from this sum to get at the figure of profit after tax (PAT). This amount is reported in the balance sheet of the company as the retained earnings of the period. With this amount, the dividends for the period are declared and distributed in the shareholders of the company.
How to arrive at the operating income figure
In order to arrive at the operating income figure, it is necessary that the company deducts all the expenses and adds all the incomes to and from the gross profit figure. To deduct the figure of the operating income, following format is used:
Profit before interest and tax = revenue – operating expenses + non-operating income
The operating income of the company helps the investors in determining the worth of the company for a potential buyout. The operating income of the company determines the potential earnings of the company, and this is one of the key factors in the decisions for a potential buyout. The gearing ratio of the company is determined after that. In order to arrive at the figure of PBIT, the costs of goods sold (Opening stock + purchases – closing stock), selling and administration expenses are deducted from the revenue. The figure that remains is the PBIT and this figure yet includes the element of interest and taxation in it. When the interest is eliminated, this figure becomes profit before tax (PBT). Once the tax is also eliminated, we can reach the figure of profit after tax (PAT). This figure is the retained earnings of the company, and it is included in the balance sheet of the company as the funds yet to be distributed to the shareholders or the funds retained for the future operations of the company.