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Whether you’re a veteran retailer or just beginning to plan your store, it’s important to familiarize yourself with a few key financial terms that will help you measure your growth, communicate your progress to investors, and, simply, figure out what works and what doesn’t. Was it worth it to stock up on those TikTok-viral friendship bracelets? Did that guerilla-marketing effort increase sales?
Two effective measurements for questions like these are operating income and net income. While both represent the income earned by your retail store, each shows different ways of expressing your earnings.
Understanding where your profits come from is key to long-term success. So, below we’ll dive into the differences between operating income and net income and cover why you may want to use one over the other, or both, as you navigate your retail journey.
What is operating income?
Also known as operating profit, operating income is the profit you have left after the cost of goods and your day-to-day operating expenses.
This metric is used to assess a company’s performance without including interest, taxes, and nonrecurring expenses. Without those factors, you can take a clear look at the day-to-day cost of running a business. Usually, a higher operating income means that you’re managing your business expenses, overhead, and production costs effectively.
How is operating income calculated?
You can calculate your operating income with the following equation:
Operating income = gross income − operating expenses
Operating expenses include:
- Rent or mortgage on your retail space
- Utlities
- Store and office tech (like computers and phones) and furniture
- Salaries for your employees
- Advertising and marketing expenses
- Insurance costs
- Software subscriptions, like Salesforce, QuickBooks, or Microsoft Office
Operating expenses do not include:
- Investments in other firms
- Taxes
- Interest expenses on debt or income taxes
- Income from nonoperating sources like stock dividends or money you make from the sale of investments or assets
Let’s try an example to put this information to the test. Say you own a clothing store and would like to calculate your operating income for Q1. Here is the information you’d need to figure that out:
- Total sales: $55,000
- Cost of goods sold: $18,000
- Rent: $5,000
- Utilities: $1,000
- Payroll: $8,000
- Advertising: $1,000
To calculate your operating income, you’ll take your total sales ($55,000) and subtract your cost of goods sold ($18,000) and your operating expenses ($5,000 + $1,000 + $8,000 + $1,000).
Your operating income would be $22,000.
The same formula can be expressed slightly differently. This formula simply breaks out operating expenses into categories.
Operating income = sales or revenue − COGS − SG&A − depreciation − amortization
But what do all those terms mean? Let’s break this equation down:
- Revenue: Your gross sales profits
- COGS: Cost of goods sold or what it costs to stock your store
- SG&A: Selling, general, and administrative expenses. These are expenses involved in running your store but not directly related to production activities. (Find some examples below.)
- Depreciation: Depreciation is a reduction of the cost of a fixed asset, which could include your building, computers, furniture, and office equipment. Essentially, it accounts for the decreasing value of products you use over time.
- Amortization: Amortization is the practice of spreading the cost of an intangible asset (like a patent, brand, trademark, or copyright) over its useful life. So if you copyrighted the name of your store, it would fit under this umbrella.
What is net income?
Net income, or your bottom line, takes into account all of your revenue and expenses, including income from investments and the sale of assets, taxes, and interest. In other words, it’s calculating all your income, including one-time gains and losses that aren’t related to your day-to-day operations.
Big picture: Net income measures your company’s profitability—and illustrates how unexpected expenses might impact your business.
How is net income calculated?
You can calculate your net income with the following equation:
Net income = revenue – COGS – expenses
A key difference from the operating income formula is that when you’re calculating net income, your expenses can include not just general and administrative costs and operating expenses (like rent and utilities) but also income taxes and interest on loans.
Let’s calculate your Q1 net income for your clothing store:
- Total revenues: $55,000
- Cost of goods sold (COGS): $18,000
- Rent: $5,000
- Utilities: $1,000
- Payroll: $8,000
- Advertising: $1,000
- Interest expense: $800
First off, calculate your gross income by taking your total revenue and subtracting COGS:
Gross income = $55,000 – $18,000 = $37,000
Next, add up your expenses for the quarter.
Expenses = $5,000 + $1,000 + $8,000 + $1,000 + $800 = $15,800
Finally, calculate your net income by taking your gross income and subtracting expenses:
Net income = $37,000 – $15,800 = $21,200
So, your net income is $21,200.
With this money, you can now invest in new projects or equipment (like new computers or better software), get that new display shelf you’ve been wanting, pay off any lingering debts, or save for a rainy day.
Should you use one metric over another?
Both operating income and net income are important metrics to measure your retail store’s profitability, but for different reasons.
Operating income gives you a good idea of your ongoing operational costs. If you have potential investors, they may want to look closer at your operating income to see how efficient your business is compared with your competition or industry averages. It can also provide them with an idea of how you might profit long term.
Net income is vital for your own business planning. You’ll want to track your one-time costs, debts, and gains to see how you’re really netting out at the end of the year. It’s a picture of your profitability for the year and takes into account unexpected or one-off costs.
Looking at these two numbers can also help you figure out where your profit is really coming from: whether it’s the sale of those popular jackets or the sale of an asset you were holding onto. It may inspire you to rethink your operating expenses. Maybe your rent is too high or perhaps your advertising efforts didn’t show a return on investment (or maybe they did).
Final thoughts
Ultimately, knowing what you’re spending and what’s coming in is key to running a successful long-term business. The more you know, the better you can prepare for the unexpected and the more aware you can be of your big wins.
