Gross Profit vs. Operating Income: Key Differences Explained

Key Takeaways

Financial metrics like gross profit and operating income play a central role in financial analysis, revealing how effectively a company generates earnings at different stages. Gross profit highlights the impact of direct production costs by showing how much revenue remains after covering the cost of goods sold (COGS). Operating income accounts for broader operating expenses, showing the company's operational efficiency.

Understanding Gross Profit and Operating Income 

Both the operating income and gross profit show the income earned by a company. However, the two metrics have different credits and deductions considered during their calculations. Both systems are essential in analyzing a company's financial well being.

What Is Gross Profit?

Gross profit is the income earned by a company after deducting the direct costs of producing its products.1 For example, if you sold $100 worth of widgets and it cost $75 for your factory to produce them, then your gross profit would be $25. Gross profit is calculated as: 

Gross profit = Revenue - Cost of Goods Sold1

Revenue is the total amount of sales generated in a period.2 You'll often hear analysts refer to revenue as the top line for a company and that's because it sits at the top of the income statement. As you work your way down the income statement, costs are subtracted from revenue to ultimately calculate net income or the bottom line.

The cost of goods sold (COGS) is the direct cost associated with producing goods. COGS includes both direct labor costs and any costs of materials used in producing or manufacturing a company's products.3

Gross profit measures how well a company generates profit from its direct labor and direct materials. Gross profit doesn't include non-production costs such as administrative costs for the corporate office. Only the profit and costs associated with the production facility are included in the calculation. Some of the costs could include:

• Direct materials
• Direct labor
• Equipment costs involved in the production
• Utilities for the production facility
• Shipping costs3

Exploring Operating Income

Operating income is a company's profit after subtracting operating expenses or the costs of running the daily business. For investors, the operating income helps separate out the earnings for the company's operating performance by excluding interest and taxes, which are deducted later to arrive at net income.4

These operating expenses include selling, general and administrative expenses (SG&A), depreciation, and amortization, and other operating expenses. Operating income does not include money earned from investments in other companies or non-operating income, taxes, and interest expenses.5

Also, any nonrecurring items are not included, such as cash paid for a lawsuit settlement. Operating income can also be calculated by deducting operating expenses from gross profit.

A Real-World Example of Gross Profit and Operating Income 

To illustrate the difference between operating income and gross profit, we'll analyze the income statement from J.C. Penney for the year ending in 2017, as reported in its 10K annual statement:

• Revenue or Total Net Sales = $12.5 billion. The net sales are its top line.
• Gross Profit = $4.3 billion (Total revenue of $12.5 billion - COGS of $8.2 billion).
• Operating Income = $116 million (highlighted in blue below). The expenses that were deducted beyond the gross profit calculation sit below COGS to arrive at operating income. In calculating operating income, costs and expenses were deducted from net sales, including the cost of goods sold of $8.1 billion and SG&A of $3.4 billion (costs not directly tied to production), for a total of $12.39 billion (highlighted in red below).
• Net income = -$116 million (a loss), which included interest in outstanding debt of $325 million, putting the company in the red. 6

The Bottom Line

J.C. Penney reported operating income of $116 million during the period, indicating that its core operations were profitable. Once debt servicing and other non-operating expenses were taken into account, the company recorded a net loss for the year. This highlights why investors must analyze financial statements at multiple levels rather than relying on a single figure. Evaluating metrics at different stages of the business cycle can lead investors to very different conclusions about a company’s performance. This example underscores the importance of using multiple financial metrics to accurately assess profitability.