Operating Income Vs Net Income

THOMAS BUTTROSS: This lesson is on operating income versus net income. Most students who are taking a managerial accounting course or study managerial accounting have already had a course in financial accounting, and they don't always understand the connection between the financial accounting course and their new managerial accounting course. So the learning objective here is to understand how operating income used and managerial accounting differs from net income used in financial accounting.

Here is the income statement used in financial accounting. It starts with total revenues from operations. From that, cost of goods sold is subtracted to get a subtotal called gross margin or gross profit. Subtracting operating expenses yields a subtotal called income from operations. Income from operations, when you turn those words around, is operating income, which is used frequently in cost or managerial accounting.

After income from operations, the organization might have some non-operating revenues, such as interest revenue. Interest revenue is considered financing revenue, not operating revenue, unless of course you are a financial institution. If you were a bank, the interest revenue would be up at the top, in the revenue from operations section.

Then the organization could have some non-operating costs or expenses, such as interest expense. Interest expense is considered a financing expense, not an operating expense, unless of course you are a financial institution. If you were a bank, the interest expense would be above operating income in the operating expenses.

That provides a subtotal called income before income taxes. Subtracting income taxes provides an income from continuing operations. Notice the slight change. Above was income from operations, and here it is income from continuing operations.

Then you add or deduct discontinued operations, and add or deduct extraordinary items depending on whether these things caused a profit or a loss, resulting in net income used in financial accounting. There's one important exception to the use of operating income as covered in the previous discussion. While the interest in income taxes come after operating income, where they affect a managerial decision, they are included in the analysis.

You may be wondering why we ignore the non-operating revenues, non-operating expenses, discontinued operations, and extraordinary items in managerial accounting. We ignore these items because they're not recurring, or they're not relevant to the decision that is being made. If they're not going to recur every year, and we are trying to make decisions involving the future, then it would not make sense to include things that are not recurring. This is the end of operating income versus net income.