How To Calculate Net Operating Income
To calculate net operating income, you need to subtract the cost of running your business (operating expenses) from your gross operating income.
Net Operating Income (NOI) = Gross Operating Income (GOI) – Operating Expenses
In this equation:
- Gross Operating Income (GOI) refers to your net income from business operations or total revenue from sales minus the cost of goods sold(COGS).
- Operating Expenses (OpEx) include all the costs directly associated with running your business, such as rent, payroll, and property taxes.
Net Operating Income Calculator
Your net operating income
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Net Operating IncomeExample
Say you had a gross operating incomeof $300,000 and the following expenses in the last quarter:
Total Expenses = $325,000, broken down as:
- Payroll = $100,000
- Rent = $35,000
- Sales and Marketing = $85,000
- Debt payments = $50,000
- Income taxes= $55,000
Your total operating costsinclude only payroll, rent, and sales and marketing, which total $220,000. When you plug that into the net operating income formula, you get
NOI= Gross Operating Income– Operating Expenses
NOI= $300,000 –$220,000
NOI= $80,000
What Costs Are Not Included in Net Operating Income?
Net operating incomeonly looks at the revenue earned from your core business activities and your total operating expenses.
It doesn’t include costs related to financing the business or income taxes.
Specifically, net operating incomedoesn’t include
- Debt payments: Interest on loans and the principal payments. These are related to financing the business and are not part of the core business model.
- Income taxes: This is a cost of being a business owner rather than running the business.
- Depreciation: Depreciationis not an actual expense. You’ll only consider it during the sale or purchase of an asset.
- Capital expenditures: Big buys are not part of the business, as they are related to the investment activities, not the core business operations. Examples include buying new machinery, office furniture, and maintenance.
- Amortization: This refers to the accounting practice of spreading out loan payments over time. Amortizationcomes with debt and isn’t included in NOI calculations.
When looking at income sources, net operating incomeonly uses sales revenue. In other words, it doesn’t include income from non-core business activities, such as the sale of an asset, rental income, or investment earnings.
Net Operating Incomevs. Net Income: Crucial Differences
While taking away operating expensesfrom gross revenue gives you the net operating income,net income refers to the difference between all business revenue and all business expenses.
Net income chart by month in Mosaic
These terms are different in meaning and shouldn’t be used interchangeably. Use each where necessary and with the right formula.
Net operating income vs. net income comparison
Since debt expenses can turn positive net operating incomeinto a net loss, looking at operating income is especially useful for young SaaS companies relying on debt financing.
Net IncomeExample
If we use the same information from the previous example:
Gross Operating Income= $300,000
Total Expenses = $325,000
Then your net income would be:
Net Income = Gross Operating Income– Total Expenses
Net Income = $300,000 – $325,000
Net Income = –$25,000
After accounting for debt and tax provisions, your bottom line is a net loss of $25,000 for the quarter. This is despite having a net operating income of $80,000.
That’s why looking at the difference between top-line and bottom-line growthis crucial. It lets you determine if your core business is profitable without counting interest expensesor income taxliability.
Best Practices to Increase Net Operating Income
At a high level, you have two possible approaches for improving net operating income: increase revenue or decrease operating expenses.
Increase Revenue
There are several approaches you can take to increase revenue, such as increasing sales volume by ramping new AEs, introducing new products, and changing your SaaS pricing strategy.
When thinking long-term about your net operating income, consider thefinancial efficiency of your approach and look for strategies that offer the highest potential return on investment.
Instead of automatically thinking you need to increase the size of your sales force, consider strategies such as product-led growth (PLG). One study found that PLG companies generate 1.7x more gross profit than primarily sales-led organizations.
You can hone in on metrics that boost growth, including net recurring revenue (NRR). SaaS companies with an NRR of 110% or higher are more likely to reach or exceed the Rule of 40growth benchmark than those with lower retention.
Finally, you can change your pricing structure by opting for usage-based pricing and introducing longer contract terms to improve revenue growth and retention.
Decrease Operating Expenses
Running your business more efficiently is another way to improve net operating income. One way to reduce operating expensesis by reducing your spending on extra business expenses such as unused subscriptions and privileges.
Then, you can perform a cash flowanalysisor, more specifically, look at your expense compositionto identify your most significant cost drivers and focus on reducing them.
Expense composition by category in Mosaic
For instance, you can reduce payroll expenses by hiring freelancers instead of full-time employees.
Ultimately, you can only reduce costs so much. So it’s essential to focus on optimizing both sides of the equation.
Tracking your revenue sources, renewal rates, and cost drivers over time will help you notice trends that affect your NOIand look for opportunities to improve it.
How to Stay on Top of Your Net Operating Income With Mosaic
Net operating income is a core profitability metric for tracking the health of an organization. But like most other financial metrics, it’s only as valuable as the context you put around it.
A holistic view of is critical to strategic decision-making about sustainable growth and continuing down the path to profitability.
Mosaic connects to your critical source systems —your ERP, HRIS, CRM, and billing systems — to create a connective tissue across all financial data in your org. That connective tissue is what helps you gain the holistic view a strategic finance leader needs to thrive in their role.
Request a demo today, and our team will show you how to take advantage of Mosaic features to make better and more informed business decisions.
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