How to work out operating profit

Net profit and gross profit are familiar terms, but operating profit is slightly more uncommon. Operating profit is a different way of calculating how much money your business makes. Where other types of profit can vary year-on-year, operating profit provides a more consistent view of your company’s financial performance.

In this article, we’re going to learn: 

• What is operating profit?
• Why use operating profit?
• How do you increase operating profit?
• How can you keep track of your finances?

Where net profit takes all of your costs into account, operating profit only uses the costs of operation (rent, bills, inventory costs, etc.). Other fees, like debt, taxes, and one-off purchases, aren’t included. You can use the formula below to work out operating profit: 

Operating profit = Revenue – Operating costs

If your operating costs end up being higher than your revenue, you’ll end up in an operating loss. In this case, your business is not sustainable, and you’ll need to figure out where to cut costs or improve revenue. 

Operating profit also takes depreciation into account, as part of your operational costs. Deprecation is the value an asset loses for each year you own it. For instance, if you become a taxi driver, you would need to account for your car’s loss in value. 

Figuring out and keeping track of depreciation is a way to spread the cost of equipment over multiple years. Instead of filing the entire cost of equipment under one year and causing profits to look worse, the price is split and spread across the projected lifetime (how long you estimate the equipment to last). 

Calculating finances like this helps to maintain more accurate records of a company’s profitability, rather than showing significant changes in profit and loss. 

In some cases, operating profit can give a much more accurate view of a company’s profitability than other methods. For example, if you spent an extra £5,000 on new equipment, net profit would take those costs into account, and it would seem like your business wasn’t performing well that year. On the other hand, operating profit only takes part of those costs and shows you how profitable your company would be without those one-off purchases.

To compare the three types of profit:

• Gross profit — shows how much you make on your goods and services
• Operational profit — shows how much money you make through general operation
• Net profit — shows how much cash you have left after all costs considered

Using accurate records of your operating profit can be extremely useful in managing how well you run your business. These records can demonstrate how you control costs and if your business is sustainable. If your records are accurate, you may be able to use them in your pitch when asking for a loan. 

Knowing how your business compares to others in your industry is critical for monitoring performance. You can easily calculate your profit margin with this formula:

Operating profit margin = (Operating profit ÷ Revenue) × 100

You can then use your margin to compare yourself to the industry average. If you’re below it, then you know there is room for improvement. The two main ways of increasing your margin are by increasing your revenue, or decreasing your costs. 

There’s not just one way to reduce your costs. One of the easiest costs to reduce could be how much you spend on your supplies. 

For example, if you plan to start a cleaning business, you could bulk buy your supplies in order to reduce overall supply costs. If you order your supplies through a supplier, you may be able to build a rapport and further reduce your price per unit. 

An alternative to buying in bulk could be changing suppliers or switching to a less expensive product. Just like comparison shopping, it’s important you frequently scout around to make sure you are getting the best value for money. 

It’s crucial to remember that using cheaper supplies could hurt your output. Using the same cleaning business example, a cheaper cleaning agent may not be able to remove all the dirt from a client’s carpet. 

If you are struggling to cut costs, another method of improving profit is to raise your prices. Be careful not to raise your prices too high, as this can end up chasing away your customers and damaging your revenue. 

E.g., If you ran a dog-walking business and typically charged £10 per dog per hour, you could increase your prices to £12.50 per dog per hour. If all your customers were happy to pay this inflated price, you would have increased your revenue by 25%.

Keeping your business profitable is the main goal of business owners, because a more profitable business means more money taken home. 

Working out your operating profit and trying to manage your various costs can be tricky and overwhelming, especially for new and growing businesses. That’s why thousands of business owners use the Countingup app to make their financial admin easier. 

Countingup is the business current account with built-in accounting software that allows you to manage all your financial data in one place. With features like automatic expense categorisation, invoicing on the go, receipt capture tools, tax estimates, and cash flow insights, you can confidently keep on top of your business finances wherever you are. 

You can also share your bookkeeping with your accountant instantly without worrying about duplication errors, data lags, or inaccuracies. Seamless, simple, and straightforward! 

Start your three-month free trial today. Find out more here.