Adjusted operating income: The ins and outs explained

Knowing how your startup's operations are doing financially can be a confusing task. It can be difficult to determine which costs to think about, which ones to exclude, and how far ahead to plan.

With so many financial metrics to track, it’s tempting for startups to just focus on total revenue. However, this can be misleading and won't give a complete picture of your business's financial performance.

Adjusted operating income is one helpful metric that allows you to isolate and focus on your day-to-day operational costs. 

By understanding what adjusted operating income is, you gain a clearer understanding of your actual operating performance and make informed decisions on how to cover your core business operations and maximize your profit.

Read on to learn what adjusted operating income is, how to calculate it, and why it's critical for your startup's financial health.

What is adjusted operating income?

Adjusted operating income (AOI) is  a company's income after taking out operating expenses and adjusts for non-operating items like interest, taxes, depreciation of property and equipment, and amortization. 

By calculating this way, you’re able to exclude any impact made by non-operating earnings or debts like stock appreciation, restructuring costs, or interest payments. 

How does it differ from operating income and net income?

Operating and net income are connected to adjusted operating income, but they offer different insights into your company's financial health.

Operating income:

Like AOI, operating income is calculated by subtracting operating expenses, such as wages and cost of goods sold (COGS), from operating revenues. However it doesn't exclude the impact of non-operating items like interest, taxes, depreciation, and amortization. 

This means operating income shows your current financial situation but doesn't reflect your cash flow or your day-to-day business performance accurately.

For example, let's say you're paying interest rates on the lease of your company's building. Operating income would include these payments in your expenses and therefore reduce the total operating income calculation. 

However, adjusted operating costs would exclude the interest payments. Because these interest payments likely fluctuate between financial periods, the AOI calculation allows you to focus on the more stable aspects of your operational finances.

Net income:

Net income gives a complete financial picture by considering all sources of income and expenses, including non-operating items. 

To calculate, it takes the total amount of money your company earns, including operational and non-operational items, and removes expenses. It's the bottom line of your company's income statement and represents total profits after you account for all fees, taxes, and other costs. 

While your net income is certainly an important financial metric representing your final profitability, AOI provides a more focused view of your company's long-term profitability by taking away the influence of external factors that might not be related to your regular operational performance.

Why is AOI important for startups?

By ignoring non-core expenses like interest, taxes, depreciation, and amortization, AOI gives you and your company's investors and stakeholders a more accurate representation of your income, expenses, and operational profitability and performance. 

This can help you understand the efficiency of your core business operations more clearly.

Because non-operating expenses aren't directly related to your regular core business operations and often fluctuate, removing the effects of them gives you numbers that aren't skewed or unstable.

By tracking AOI over time, you can identify regular trends in your operating performance and make informed decisions to improve your long-term financial health, for example by automating certain processes.

AOI also provides a clear picture of your startup's ability to generate cash flow from operations. This is especially critical for startups that don't yet have a positive net income. 

A positive adjusted operating income indicates that your business is generating cash from its day-to-day operations regardless of irregular or non-operational funds, which is essential for long-term sustainability and proving your ability to handle your operations to investors. 

And because AOI is a common measurement, you can use it to compare your company's operational performance with that of you competitors.

How to calculate AOI

There are different ways to calculate AOI depending on your company's specific circumstances, but the most common formula involves the following variables:

• Operating income: your company's earnings from core operations, which is calculated as revenue minus operating expenses.
• Non-operating expenses: any expenses that your company incurs outside of core operations, such as interest expenses or losses from the sale of assets.
• Depreciation and amortization: these are expenses related to the depreciation of fixed assets and the amortization of intangible assets.
• Other unusual operating expenses: any other irregular or fluctuating expenses that may skew true earnings from your core operations, such as restructuring expenses or one-time gains or losses.

You can then combine these variables into the following formula:

Adjusted operating income = operating income - non-operating expenses - depreciation and amortization - other unusual operating expenses

Is AOI the same as EBIT?

Adjusted operating income is similar to but not the same as Earnings before interest and taxes (EBIT).

EBIT is a financial metric that measures your company's operating performance before considering interest and taxes. It's calculated by subtracting your operating expenses from your operating revenue but includes no adjustments for non-operating items such as depreciation and amortization.

What is the AOI margin?

The adjusted operating income margin is a financial metric that shows the difference between your adjusted operating income and your net sales. Your net sales are your total sales minus any returns, allowances, or discounts.

You calculate it using the following formula:

Adjusted operating income margin = adjusted operating income / net sales

This margin between your AOI and sales can indicate the efficiency and profitability of your operations and show any room for improvement. A higher adjusted operating income margin is a sign that your company's operations are doing well, while a lower margin may suggest difficulties and inefficiencies.

Making the most of your startup's financial data

As a startup founder, you want to do everything you can to ensure the success of your startup and keep up your operational efficiency. 

Understanding and using adjusted operating income helps you track your company's performance over time, identify areas for improvement, and make decisions that will make your business more efficient, sustainable, and attractive to investors. By removing the effects of non-operating and irregular costs and payments, you can get a good idea of your day-to-day operational profitability.

If you feel nervous or overwhelmed about monitoring this data yourself, you can always seek out expert accountant support. These experts can assist with calculations and offer resources and training to help you understand important financial metrics like AOI.