One of the basic objectives of all for-profit business entities is to generate income or profit for their owners. The total income generated by a business can be segregated into two types – operating income and non-operating income.
The operating income has the primary importance for any business i.e., it is the basic type of income for which a business entity was primarily established or developed. The non-operating income, on the other hand, has the secondary importance i.e., it is the additional income earned by a business in result of undertaking some additional economic activities that cannot be regarded as the core business activities of the entity. For example, income earned through the sale of merchandise is the operating income for a merchant. However, if the same merchant rents out the additional space of his warehouse to another merchant, the rental income received by him would be treated as non-operating income because the core business activities of a merchant include buying and selling merchandise and not renting out buildings or warehouses.
This article is focused on defining and explaining the difference between operating and non-operating income.
Definitions and meanings:
The operating income (also referred to as operating profit) is the basic or primary income that a business derives solely from its core operations. On the income statement, operating income is commonly reported as line item before non-operating income.
For any business, the operating income figure can be computed by deducting cost of goods sold and all operating expenses from the revenue realized through primary business operations. The primary business operations are the primary revenue generating activities that a sole proprietor, firm or company undertakes in its ordinary course of business. Some common examples of such activities in various industries are given below:
- Sale of merchandise by a merchant or retail company like Walmart
- Sale of various types of furniture by a furniture manufacturing company like Ashley Furniture Industries
- Sale of all types of ready-to-wear cloth by a fashion retailer like Toby
- Medical services provided by a health expert or hospital like UCSF Medical Center
- Accounting and auditing services provided by an accounting firm like Deloitte LLC
- Legal consultancy provided by a law firm like Ropes and Gray
- Web hosting services provided by a web-hosting company like Go Daddy
- Search engine optimization (SEO) services provided by an SEO company like Hoth
The computation of operating income in equation form can be presented as follows:
Operating Income = Total revenue from operations – Cost of goods sold – Operating expenses
Many businesses also earn non-operating income in addition to operating income. The non-operating income (also referred to as non-operating profit) is the income that a business earns from other than its primary business operations. It can be a regular income like rent, dividend or interest or a one-off income like gain on sale of investment.
In a multi-step income statement, the non-operating income is often computed and presented in a separate section known as non-operating income section which usually appears near the bottom of the income statement. In this section, any non-operating expenses or losses are deducted from the total non-operating revenues or benefits and the net amount is reported as line item below the operating income.
Some examples of non-operating revenue and expense items involved in the computation of non-operating income are as follows:
- Dividend income from other entities
- Interest on investment in other entities
- Rental income from a building, hall or another premises
- Gain on sale of a fixed asset
- Gain on sale of investment in debt or equity securities of another company
- Gain resulting from undertaking foreign currency transactions
- Loss on sale of a fixed asset
- Loss on sale of investment in debt or equity securities of other companies
- Loss resulting from undertaking foreign currency transactions
In equation form, the computation of non-operating income can be presented as follows:
Non-operating income = All non-operating revenues or benefits – All non-operating expenses or losses
Difference between operating and non-operating income:
The main points of difference between operating and non-operating income are elaborated below:
1. Primary distinction:
Operating income is the effective earning of a company before subtracting interest and tax expense. The earnings before interest and tax (EBIT) and operating income of a business will be the same if business has no other non operating income and expenses to add or deduct. On the other hand, any income that a business receives from non-core business operation is known as non-operating income. This income comes from any source which differs from the primary mode of profit-earning of the business.
Interest income, rental income, dividend income, profit realized on the sale of a fixed asset etc. are some types of non-operating income while operating income is the income generated from the main business activities of a business. For example, if a business runs a cab service, the income that will be generated by its taxi drivers will be considered as the operating income for the company. Now, if the same company owns a building which it has rented out, the rental income generated from this building will be referred as non-operating income because it is other than the ordinary course of business activities.
For example, JT Co. Ltd. is a bag manufacturing company. The extracts of its income statements for two consecutive years is as follows:
|Income Statement line Items||Year 2||Year 1|
|(Cost of Goods Sold)||–||(38,560)||–||(35,890)|
|(Selling & Marketing Expenses)||(2,300)||–||(1,857)||–|
|Profit Before Interest and Tax||10,404||4,598|
It can be seen that operating income is calculated after deducting the production cost of the bags sold (i.e., cost of goods sold) and operating expenses (selling, marketing, distribution administrative) which are necessary to sale the products of JT Co Ltd. from the total revenues. The sum of all income which is obtained from non-key activities of the business (in this case rental Income and dividend Income) are referred as non-operating income.
4. Use in decision-making:
The operating income figure is very useful for management and shareholders of a company to measure the operational performance of their company because the operating income is all the income that is earned in result of primary business activities. Interest and tax expenses are not taken into account while computing operating income because these expenses are not under the control of management and therefore do not become part of their performance evaluations. Operating income can be used to compare and assess a business’s financial results from different years which can highlight the effectiveness of business operations in different comparatives.
For instance, in above example, the results of both years can be compared with each other to extract analysis like calculation of different financial ratios and comparison of different line items etc. These results can be used for robust internal decision making to cope up with the deficient areas of the business. However, non-operating income is irrelevant in this regard because mostly it makes a small portion of a company’s income. Secondly, management’s decisions do not have any direct effect on this type of income. For example, if a business has invested money in another company’s shares, it will receive dividends according to the policies of management of the other company.
Operating versus non-operating income – tabular comparison
|The income which is generated from the core commercial activities of a business.||The income that is generated from any non-core activities of a business.|
|Income produced from selling primary goods or services of a business.||Rental income, dividend income etc. are some types.|
|Is vital in decision-making and evaluation process of a company’s results because it varies directly based on the decisions made by management.||Is not very essential in the decision-making process of the company, but it can be still managed or administered.|
Conclusions – operating vs non-operating income
Businesses are commercial entities which operate with a primary focus to earn profit and always strive to remain profitable in order to sustain their going concern status. The big portion of profit for any business comes from its main sales or supply of services. Therefore, it is essential that management of a business regulates and plans to constructively grow these activities in order to develop their business further.
Although, non-operating incomes are not of crucial nature, still they can be administered especially if management plans to increase portfolio of its core operations. Additionally, irrespective of the nature, all the expenses and incomes of a business must be completely disclosed in the relevant financial statements to make them useful for stakeholders.