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What is operating profit?

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Operating expenses comprise all expenses that are incurred in carrying out a firm’s ordinary activities, including advertising, salaries, rent, research and development, office supplies and any other administrative expenditure.  An operating expense is a period cost, which is a nonmanufacturing fixed cost that is charged as an expense in an accounting period rather than assigned to a product, including the costs in managing the company, administration as well as selling and distributing the manufactured products and the inventory of the company:

  • Selling and marketing cost – An expense relating to the selling and marketing of products and services, it usually includes advertising, distribution costs and the salaries, commissions and expenses of sales staff; and
  • Administrative expenses – An expense incurred in the administration of the firm as a whole, which include the salaries of top management, general office expenses and legal expenses.

It is not uncommon for depreciation expense to be included in operating expenses.  Depreciation expense the amount of historical cost or other cost base of a fixed asset or group of fixed assets charged against the operations of the accounting period and credited to accumulated depreciation.

Operating revenue and expenses resulting from transactions that are not a company’s principal business activity are classified as other operating income and other operating expenses, respectively.  They are usually minor compared to revenue and expenses from the firm’s ordinary activities.

Operating profit is the overall performance of an accounting entity’s operations before considering nonoperating revenue and expenses, extraordinary items and income taxes, it reporting the second profit metric in a multiple-step income statement.  Operating profit is often represented by EBITDA.

Arriving at Operating Profit
      Gross Profit
−    Selling Expenses
−    General and Administrative Expenses
    Depreciation Expense                     
=    Operating Profit (Loss)

A firm’s earnings before interest, taxes, depreciation and amortization (EBITDA) measures its underlying cash flow and ability to service its debt, computed by adding interest expense, depreciation expense and amortization expense back to pretax income.  A firm’s earnings before interest and taxes (EBIT) is calculated by adding interest expense back to pretax income.

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