Net Operating Income: Meaning, Factors & Formula

How can you get a closer view of your business’s operational efficiency and profitability? Does this keep you worried about the complexities of finance planning and tax liabilities? There is a better way to assess your financial health. And it is by calculating Net Operating Income (NOI). The benefit of using NOI is a vital step for making an informed investment decision and comparing opportunities on their income potential.

What is the net operating income for your business?

An important financial formula to measure the profitability of a business or investment property by calculating the income made from operations after subtracting is Net Operating Income (NOI).

NOI eliminates non-operating expenses like interest, taxes, and capital expenditures, giving a clear understanding of the income generated only from operational activities. It is often used in the real estate industry to evaluate the profitability of rental properties like office buildings, apartment complexes, or warehouses and in general business analysis to evaluate operational efficiency.

Net operating income (NOI) is normally calculated annually, to justify seasonal or irregular expenses, such as landscaping, snow ploughing, or window washing. All these expenses maintain the overall value and operation of the property or business just like operating costs are vital to calculating NOI.

NOI measures the potential return on investment of a property based on its purchase price using capitalization rate.

How do you calculate net operating income (NOI) for your business?

The net operating income formula is given below:

Gross operating income − operating expenses = NOI

To get both variables of this equation we need to know a few steps. Gross operating income is the result of gross potential income or the maximum a property produces if all its rental space is filled. Any lost income due to vacancies or unpaid rent is subtracted from gross potential income. Then subtract operating expenses.

Here is an example of an annual NOI calculation. Let us imagine an office building with the following specs and statistics:

Office space: 75,000 square feet
Rental rate: $30 per square foot, annually
Gross potential income: 75,000 × $30 = $2,250,000
Income from vending machines: $25,000

Accounting for the building’s net operating income can look like this:

Gross Operating Income 

Then subtract the following from gross operating income:

Operating Expenses 

With both variables, you can tally the NOI using the equation:
 

$2.2 million − $600,000 = $1.6 million

We can calculate the cap rate by dividing the NOI by the current market value of the property. Suppose the owner paid $20 million for the building. In this case, the cap rate calculation (NOI / market value of the property) looks like this:

$1.6 million / $20 million = 0.08 or 8%

What are the factors that affect net operating income?

Net operating income and the cap rate can vary based on the following factors:

• Rent and vacancy rates: Income on rental property can increase if an owner raises rental rates, fills vacancies, or collects delinquent rents. On the other hand, lower rental rates and more vacancies and delinquencies cut rental income.
• Operating expenses: Property taxes may increase (or rarely decrease), and insurance, utilities, and maintenance costs can rise or fall.
• Market condition. An economic boom or slowdown can cause vacancies and delinquencies to increase or decrease. The same applies in regions where housing or office space supplies have a low demand.

What is the difference between Operating Income and Net Income?

Operating income and net income both show the income earned by a company, but they represent distinctly different ways of expressing a company's earnings. Both metrics have their merits but also have different inferences and credits involved in their calculations. It's in the analysis of the two numbers that investors can say where in the process a company began earning a profit or suffering a loss,

The table here gives the key differences between Operating Income and Net Income:

FAQs

Q1. How does operating income affect net income for your business?

Ans. Operating income is essentially revenue less any operating expenses, while net income is operating income less any other non-operating expenses, such as interest and taxes. Operating expenses include selling, general & administrative expenses (SG&A), and depreciation and amortization.

Q2. Is high net operating income considered good?

Ans. A company that is producing an increasing amount of operating income is seen as promising because it shows the company's management is generating more revenue while controlling expenses, production costs, and overhead.

Q3. What is the ideal operating income margin for businesses?

Ans. Normally a 10% operating profit margin is considered an average performance, and a 20% margin is excellent. It's also important to pay attention to the level of interest payments from a company's debt.

Q4. What is the NOI margin of a business?

Ans. The NOI margin evaluates the profitability of a property investment by comparing its net operating income (NOI) to the total revenue it generates over a specific period.