Hey everyone,
Ever walk down a street and see two businesses that look almost identical? Same product, same prices, same steady stream of customers. From the outside, you’d assume they’re both doing equally well. But as we know, what happens on the sales floor is only half the story. The real magic—or the real trouble—is often hidden in the numbers.
I want to break down one of the most powerful metrics for understanding a business's health: Operating Income. It sounds like dry accounting-speak, but it's actually a fantastic tool for getting to the heart of how well a business is actually being run.
To make this tangible, let's ditch the spreadsheets for a moment and tell a story.
Meet Shop A & Shop B
Imagine two coffee shops on opposite corners of the same busy intersection.
- Shop A is "The Daily Grind." It’s sleek, modern, and has a huge Instagram following.
- Shop B is "Brew & Co." It’s cozy, community-focused, and has a loyal following of regulars.
Both shops are incredibly popular. They sell the same number of lattes, croissants, and cold brews. By the end of the year, they’ve both brought in the exact same amount of money in sales: $500,000 in Revenue.
If revenue is all you look at, you’d call it a tie. But we're here to dig deeper. We’re going to use the operating income formula to figure out which business is truly the more efficient, profitable machine.
The formula is simple: Operating Income = Revenue - Cost of Goods Sold (COGS) - Operating Expenses (OpEx)
Let's see it in action.
The Breakdown in Action
We've managed to get a peek at the annual financial statements for both shops. Let's lay them out.
Shop A: The Daily Grind
The manager here believes in a "premium at all costs" strategy. They spare no expense to create a high-end image.
- Revenue: $500,000
- Cost of Goods Sold (COGS): $150,000
- This includes coffee beans, milk, syrups, cups, pastries, etc. They source expensive, internationally acclaimed beans.
- Operating Expenses (OpEx): $250,000
- Salaries: $120,000 (They hire highly experienced baristas and pay top-of-market rates).
- Marketing: $50,000 (A big budget for social media ads, influencers, and promotions).
- Rent & Utilities: $80,000 (Same as Shop B).
Now, let's do the math:
$500,000 (Revenue) - $150,000 (COGS) - $250,000 (OpEx) = $100,000 Operating Income
Not bad. They’re profitable. But let’s check in on their competitor across the street.
Shop B: Brew & Co.
The manager at Brew & Co. is obsessed with efficiency and community sourcing. They believe in smart spending, not just big spending.
- Revenue: $500,000
- Cost of Goods Sold (COGS): $125,000
- They spent months finding an amazing local roaster who gives them a great price on high-quality beans, saving them a significant amount of money.
- Operating Expenses (OpEx): $200,000
- Salaries: $100,000 (They have a well-trained but leaner team and focus on great work-life balance to retain staff).
- Marketing: $20,000 (They rely on word-of-mouth, local event sponsorships, and a killer loyalty program instead of pricey ads).
- Rent & Utilities: $80,000 (Same as Shop A).
Let's run their numbers:
$500,000 (Revenue) - $125,000 (COGS) - $200,000 (OpEx) = $175,000 Operating Income
The "Aha!" Moment
Take a look at those final numbers.
- The Daily Grind (Shop A): $100,000
- Brew & Co. (Shop B): $175,000
Even though both shops sold the exact same amount of coffee, Brew & Co. is 75% more profitable from its core business operations.
This is the power of operating income. It strips away the noise of things like taxes, interest payments, or one-time gains and losses. It answers one simple question: "How good is this company at its primary business?"
Shop A looks successful on the surface with its flashy marketing and high revenue, but its operational costs are eating away at its profits. Shop B, on the other hand, is a lean, mean, coffee-making machine. Its manager's smart decisions on sourcing (lowering COGS) and spending (lowering OpEx) have created a much healthier, more resilient business. If a slow month hits, Shop B is in a far better position to weather the storm.
Solve the Problem: You're the New Manager!
Okay, let's turn this into a challenge for the community.
The owners of The Daily Grind (Shop A) have seen the light. They realize their high-revenue-at-all-costs strategy isn't working, and they've just hired YOU to turn things around. Your bonus is tied directly to improving the shop's operating income.
Here are your starting numbers again:
- Revenue: $500,000
- COGS: $150,000
- Operating Expenses: $250,000 (Salaries: $120k, Marketing: $50k, Rent/Utilities: $80k)
- Current Operating Income: $100,000
You can't touch the rent, but everything else is on the table.
My question to all of you: Looking at these numbers, what are the first three changes you would make to improve Shop A's operating income? Be specific with your reasoning!
