Company managers and investors always like to know where the money a business takes in goes and how much profit it makes. Net operating income, or simply operating income, tells you part of the story. It is the pre-tax profit a firm earns from its business operations.
The Income Statement
Businesses prepare an income statement each year, one of a series of financial statements published in a firm’s annual report. The income statement provides managers and investors with information about the company’s revenues and expenditures.
Net operating income is the amount of money the business makes from day-to-day operations. This figure doesn’t count income from sources other than business operations and it doesn’t factor in financing costs or income taxes – these are dealt with later on the income statement. Investors and managers sometimes refer to operating income as earnings before interest and taxes, or EBIT.
From Sales to Operating Income
Figuring operating income starts at the top of the income statement where revenues or sales are stated. Subtract the cost of goods sold, which leaves gross profit. Next, subtract operating expenses, such as rent, utilities, salaries and insurance. What’s left is the firm’s net operating income. In the event the total operating expenses are more than the gross profit, this line of the income statement shows a net operating loss.
EBIT and the Bottom Line
Non-operating revenues and expenses are listed below the operating income line. Add gains from the sale of assets and interest earnings to operating income. Subtract interest paid on bonds and business loans. Finally, subtract income taxes, which leaves net income. Net income is the actual profit or loss for the business – the “bottom line.”
Operating Income for Real Estate
Commercial real estate businesses define the term “net operating income” somewhat differently. In the real estate context, NOI is an analytical tool that measures or estimates the ability of a property to generate a profit exclusive of financing costs and taxes. To calculate NOI for commercial real estate, begin with the maximum rental income the property can produce assuming full occupancy with all tenants paying their rent. Subtract allowances for vacancies and uncollected rent to find the effective rental income. Add other income and subtract the operating expenses of the property. The result is the net operating income.