Operating profit is the income earned from the core operations of a business, excluding any financing or tax-related issues. The concept is used to investigate the profit-making potential of a business, excluding all extraneous factors. Operating profit information is particularly valuable when monitored on a trend line, to see how a business is performing over a long period of time. If operating income is negative, a business will likely require additional outside funding to remain in operation.
Operating profit is stated as a subtotal on a company's income statement after all general and administrative expenses, and before the line items for interest income and expense, as well as income taxes.
Operating profit does not necessarily equate to the cash flows generated by a business, since the accounting entries made under the accrual basis of accounting can result in operating profits being reported that are substantially different from cash flows.
Operating profit can be falsely modified by aggressive accounting practices, such as by altering accounting reserves, changing revenue recognition policies, and/or delaying or accelerating the recognition of expenses.
A company may attempt to highlight its operating profits instead of its net profits, usually because its financing or tax costs are unusually high. If so, management is likely attempting to direct attention away from substantial non-operating costs that are a long-term component of the cost structure of the business.
As an example of operating profit, Dillinger Designs has revenue of $10,000,000, cost of goods sold of $4,000,000, general and administrative expenses of $3,000,000, interest expense of $400,000, and income taxes of $900,000. The operating profit is $3,000,000, which includes the revenue, cost of goods sold, and general and administrative expenses. The interest expense and income taxes are excluded from the calculation.
Operating profit is also known as operating income, or earnings before interest and taxes (EBIT).