The operating income of a company is the gross profit minus operating expenses. Gross profit is sales minus cost of goods sold. Operating expenses include selling, general and administrative expenses, but exclude interest and taxes. Negative operating income is an operating loss, which means that cost of goods sold and operating expenses -- combined or individually -- are greater than sales. The reasons for a negative operating income should be understood before considering turnaround strategies.
Stagnant revenues and shrinking profit margins are some of the reasons for a negative operating income, according to information on New York University professor Aswath Damodaran's website. If revenues fall but costs remain the same, profits suffer. Losses often force companies to take on additional debt, which might lead to asset divestitures to raise cash and possible bankruptcy.
Driving revenue growth could lead to a positive operating income. Managing partner Paul Blase and others of business process consulting firm Diamond Consultants cite Starbucks' strategy of re-branding sizes as synonyms of "large" instead of "short" as an example of driving higher sales dollars per unit sold. Companies should use discounts carefully because getting into a price war with the competition is generally not a recipe for long-term profitability. Sales staff should be encouraged to cross-sell company products: for example, cell phone companies often train their customer service staffs to persuade customers to sign on to long-term contracts or buy newer model phones.
Reduce Cost of Goods Sold
The cost of goods sold includes raw material and labor costs. Companies should explore ways to take advantage of available supplier capacity. For example, if over-expansion and a faltering economy have led to idled capacity, these suppliers might be open to filling that capacity at discounted prices. This reduces the cost of goods sold, which should flow through to the operating income.
Manage Operating Expenses
Companies are often in an 80/20 situation, says Blase, in which 20 percent of the customer base drives 80 percent of the profits. Focusing marketing and other investments on the most profitable customers can reduce expenses, while driving revenue and profit growth. Nontraditional marketing channels, such as the Internet and social media, can also reduce selling expenses while allowing for a more focused marketing campaign. Companies should diligently manage expenses, even during strong economic times and periods of good profit growth.
Reducing fraud can lead to improvements in the operating income, suggests Blase. Examples of fraud include improper accounting of revenues, theft of inventory items and submitting false purchase invoices.
Considerations: Tax Implications
Negative operating income, aka NOLs (net operating losses), can be used to reduce taxes payable, writes Syracuse University professor Ravi Shukla. Losses can be carried forward to reduce taxable income in the future, or retroactively applied to prior years' profits to potentially get a tax refund.
- Morningstar: Investing Glossary: Operating Income
- New York University Stern School of Business: Aswath Damodaran's Website: The Little Book of Valuation
- PricewaterhouseCoopers Diamond Consultants; Ten Tactics for Improving Operating Margins in Tough Times; Paul Blase, et al.
- Syracuse University Whitman School of Management; Taxes on Negative Taxable Income; Ravi Shukla; January 2010
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