Income from operations
|Income from operations|
Income from operations is income related to the operating activities of an entity. These revenues are presented in two parts of the income statement: In the first part, there are revenues related to the basic operating activity of the entity, i.e. for which the entity was established, e.g. sale of goods and products (M. Manglik, A. Goya, 2016, pp. 28-32).
The second part of the income statement presents income indirectly related to operating activities (so-called other operating income), e.g. resulting from the sale of redundant fixed assets. In addition to income from operations, the total income of an enterprise is made up of such categories of income statement as financial income (related to investment and financial activities) and extraordinary profits (related to random events) (M. Manglik, A. Goya, 2016, pp. 28-32).
Income from operations is generated as part of the core business of the company. Among them, there are revenues from basic operating activities and other operating revenues. Revenues from basic operating activities, also called revenues from sales, include such revenues that relate to the sale of goods or services. Other operating revenues, on the other hand, occur as an indirect effect of the sale of goods or services, and their characteristic feature is their diversity. Therefore, revenue from the main operating activities may include sales revenue (M. Manglik, A. Goya, 2016, pp. 28-32):
- finished and semi-finished products, works and services;
- trade goods and materials.
Other income from operations
Other operating income includes primarily income related to (L.D. Brown, K., Sivakumar, 2003, pp. 561-572):
- social activities (e.g. subsidizing social facilities such as holiday and colony centers, sanatoriums, nurseries, and kindergartens);
- disposal of fixed assets, fixed assets under construction, intangible assets, as well as real estate and intangible assets included in investments;
- maintenance of real estate and intangible assets included in investments, including the updating of the value of these investments, as well as their reclassification to fixed assets and intangible assets, if the market price or otherwise specified fair value was adopted for the valuation of the investment;
- write-off of receivables and liabilities that are time-barred, depreciated, uncollectible, except for receivables and liabilities of public and legal nature not encumbering costs;
- creation and release of provisions, except for provisions related to financial operations;
- write-offs revaluing assets and their adjustments, except for write-offs charged to financial costs;
- damages and penalties;
- transfer or receipt free of charge, including by way of an asset donation, including cash for purposes other than additional payments to sales prices, purchase or production of fixed assets, fixed assets under construction or intangible assets;
- random events.
For an event to qualify as other operating income, it must be determined, on a prudent basis, that it relates to operating activities and the risks associated with those activities. The precautionary principle is essential as only an undeniable operating income can be included in the income statement (L.D. Brown, K., Sivakumar, 2003, pp. 561-572).
Factors determining cash flows from operating activities
The cash flow from operating activities is determined by external factors on which the company has little influence and internal factors, depending on the decision of the management. Among external factors it stands out (Z. Puspitaningtyas, 2017, pp. 15-17):
- the business cycle and the overall macroeconomic scale
- the life cycle of the product
- barriers to entry
- the position of the company on the market
- possibility to take advantage of price competition and adjust prices of goods and services to factors of production
- the possibility to choose the production structure in line with the changing needs and expectations of the market.
Internal factors include, but are not limited to (Z. Puspitaningtyas, 2017, pp. 15-17):
- the choice of depreciation methods
- the management of resources and the sources of their funding
- pricing policy
- credit policy
- management of receivables
Ebit, ebita, ebitda
Operating income can be described in three measures (A. S. Gazzola, 2014, pp.156-158):
Ebit (earnings before interest and taxes) is the operating profit before interest and taxes. This value determines the amount of surplus created in the company from its core business, but already takes into account the costs, which are general overheads. This measure does not take into account profits from 'other operating activities'. It is a function of the amount of sales revenue and variable and fixed costs. Ebit is included in the calculations necessary to determine break-even or operating leverage (A. S. Gazzola, 2014, pp.156-158).
Ebita (earnings before interest, taxes, and amortization) is the profit from business activities, however, reduced by income tax and increased by the amortization of intangible assets. Ebita can be calculated by adding the amortization of intangible assets to Ebit operating profit. Ebita does not include depreciation of property, plant, and equipment. This is because amortization only determines the depreciation of legal and intangible assets, and depreciation is used for fixed assets (A. S. Gazzola, 2014, pp.156-158).
Ebitda (earnings before interest, taxes, depreciation, and amortization) is the profit from business activities, which is increased by depreciation. It is a very popular measure of profitability in financial analysis as well as in the valuation of companies. It is calculated as the sum of operating profit and depreciation. This measure is often treated as a simplified measure of operating cash flows because it adjusts operating profit by non-cash costs. Ebitda is most often used in credit risk analysis or company valuation (J. Ohek, 2013, pp. 4727-4736).
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- Gazzola, A. S., (2014), Is total comprehensive income or net income better for the evaluation of companies' financial performance?, 156-158
- Manglik M., Goya A., (2016), Research Paper Operating Margin Ratio (A Comparative Study of Selected Public and Private Sector Companies), "Research Paper Management", 28-32
- Ohek J., (2013), Examining analysis of operating income: From the perspective of marketing, "Information", 4727-473
- Pignataro P., (2013), Financial Modeling and Valuation: A Practical Guide to Investment Banking and Private Equity
- Puspitaningtyas Z., (2017), The Meaning Of Net Income And Operating Cash Flow In Determining, "International Journal of Current Research", 15-17
Author: Dominika Pasek