Non-Operating IncomeExplained & Defined
What is Non-Operating Income?
A company’s recognition of income derived from sources other than its primary business activity is called Non-Operating Income.
These types of income can be from gains derived from selling an old asset, dividend income, etc. They are sometimes called incidental or peripheral income.
Understanding Non-Operating Income
When gauging a company’s profitability, stability, and ability to compete in the economic market, a company should focus on studying its financial statements’ earning rate/profitability rate.
There are many situations where because of the non-operating activities, a company is still able to show high profits.
For example, if a company manages to invest and earn handsome gains in a stock market or has been able to sell real estate assets with a large amount, it can significantly skew the earnings reports.
Gains and income from other activities apart from the main business activity of the company can alter its profitability.
Because of this, it will be difficult for users, especially investors, to gauge the efficiency of the business operations if non-operating income is not reported as a separate line item in the financial statement.
Non-Operating Income vs. Operating Income
A company needs to know the origin of its revenues to account for all items in the financial statement.
Distinguishing whether the income is from the primary operation or not is vital to monitoring the performance of every income-generating unit.
Operating Income is the amount earned from its primary business activity, which is why the separate accounting of such amount is significant.
The Operating Income computation provides the intended users with the information they need to know with regard to how profitable the company is based solely on its core operations.
In the Income Statement Report, the recognition for Operating and Non-Operating Income is presented in separate line items.
Once the Operating Income is computed, directly below that, the Non-Operating Income is reported.
Example of Non-Operating Income
For example, A Retail Store is a type of business that buys inventories in bulk orders.
The nature of holding plenty of cash is just typical.
In this case, the company can have idle money which the owner may decide to invest in the stock market.
If the Retail Store invested $20,000 in a bond investment and earns a 6% interest income in just one month or $1,200.
The interest earned is recognized as gain and is part of the Non-Operating Income category.
Another example would be if an automobile company decides to sell a piece of land because it has been idle for many years for $100,000.
The recognition of sale proceeds is recognized as a non-operating income.
And if the company reported earnings of $500,000 through its primary business activity, it is easy to identify that the 20% profit increase in the total income is because of the sale of the piece of land.
A reported high income seems attractive to investors if the operating and non-operating income are not separated.
The presentation of both as separate line items in the financial statement is needed to accurately account for the company’s financial performance.
Investors and other users of the financial statement must be cautious when looking at financial reports because there are companies that lure users to invest with them by reporting high net income.
But in reality, the amount is a combined operating and non-operating income.
A perfect example is when companies only provide the Earnings Before Interest and Taxes (EBIT) because it includes income sources that are not related to the company’s business activities.
When a company reported a higher net income than it had in the previous year, there is a high probability that the spike in income is because of non-operating activities.
Investors must ask to be provided a detailed report of the company’s income sources because some companies with creative accountants can record non-operating income as part of operating income.
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Cornell Law School "47 CFR § 32.7300 - Nonoperating income and expense." Page 1 . August 25, 2022