Gross operating surplus

What Is Gross Operating Surplus?

Gross operating surplus (GOS) represents the portion of income from production that is earned by the factor of capital within incorporated enterprises. It is a key component in national income accounting and serves as a balancing item in the generation of income account in national statistics. Gross operating surplus reflects the surplus generated by production activities after covering the costs of labor and intermediate inputs, before accounting for depreciation or financial expenses. This economic indicator provides insight into the profitability of businesses before certain non-operating costs are considered. Along with compensation of employees and net indirect taxes, gross operating surplus is used in the income approach to calculate Gross Domestic Product (GDP).

History and Origin

The conceptualization and measurement of national income components, including elements that would evolve into gross operating surplus, are deeply rooted in the development of modern macroeconomics and national accounting systems. A pivotal figure in this history is Simon Kuznets, an American economist who pioneered the systematic measurement of national income. During the Great Depression, the lack of comprehensive data on national production and income became evident. In response, Kuznets, working with the National Bureau of Economic Research (NBER) and the U.S. Department of Commerce, developed the first official estimates of U.S. national income. His seminal publication, "National Income, 1919-1935," laid the groundwork for the modern National Income and Product Accounts (NIPA) still used today by the Bureau of Economic Analysis (BEA).⁵ The framework established by Kuznets helped standardize the definitions and methodologies for tracking economic activity, including the surplus generated by production units.

Key Takeaways

• Gross operating surplus (GOS) is an economic aggregate representing the income share attributed to capital in the production process of incorporated businesses.
• It is calculated before deducting consumption of fixed capital (depreciation) and before the payment of interest, rent, or taxes on income and wealth.
• GOS is a crucial component in the income approach to calculating Gross Domestic Product (GDP), reflecting the profitability of production activities.
• Unlike traditional accounting profit, gross operating surplus does not include financial income or expenses and focuses solely on the surplus from core production.
• It provides economists and policymakers with a macroeconomic view of corporate profitability and the return to capital at a national or sectoral level.

Formula and Calculation

Gross operating surplus is derived within the framework of national accounts by subtracting certain costs from the value of output. The general formula for calculating gross operating surplus is:

Alternatively, it can be expressed in relation to total output:

Where:

• Total Output refers to the total value of goods and services produced.
• Intermediate Consumption is the value of goods and services consumed as inputs in a production process (excluding fixed assets).
• Compensation of Employees includes wages, salaries, and employer social contributions.
• Gross Value Added is the value of output less the value of intermediate consumption, representing the contribution of a particular industry or sector to Gross Domestic Product.
• Taxes on Production and Imports (net of subsidies) refers to taxes paid by producers on goods and services, independent of their profitability.

It is "gross" because it makes no allowance for the consumption of fixed capital, often referred to as depreciation.⁴

Interpreting the Gross Operating Surplus

Gross operating surplus offers insights into the operational profitability of businesses within an economy or specific sectors. A rising gross operating surplus generally indicates that incorporated enterprises are generating more income from their production activities relative to their labor and intermediate costs. This can suggest robust economic growth and a healthy business environment.

Conversely, a declining gross operating surplus might signal tightening profit margins, increased costs, or weakened demand. Analysts interpret this figure to assess the overall health of the corporate sector and its capacity to invest and expand. Since it is a component of GDP calculated by the income approach, changes in gross operating surplus contribute directly to understanding shifts in national income distribution among capital, labor, and government. It helps distinguish between income derived from the use of capital (GOS) and income derived from labor (compensation of employees).

Hypothetical Example

Consider a hypothetical manufacturing company, "Widgets Inc.," for a given fiscal year.

1. Total Output (Revenue from sales): $5,000,000
2. Intermediate Consumption (Cost of raw materials, utilities, outsourced services): $2,000,000
3. Compensation of Employees (Wages, salaries, benefits): $1,500,000
4. Taxes on Production and Imports (e.g., property taxes, excise taxes, net of any subsidies received): $200,000

First, calculate the Gross Value Added:
Gross Value Added = Total Output - Intermediate Consumption
Gross Value Added = $5,000,000 - $2,000,000 = $3,000,000

Now, calculate the Gross Operating Surplus:
Gross Operating Surplus = Gross Value Added - Compensation of Employees - Taxes on Production and Imports (net of subsidies)
Gross Operating Surplus = $3,000,000 - $1,500,000 - $200,000 = $1,300,000

In this example, Widgets Inc. generated a gross operating surplus of $1,300,000. This figure represents the surplus generated from its core production activities after paying for intermediate goods, services, and its workforce, but before accounting for wear and tear on its machinery or any financing costs. This surplus is available to the company for various purposes, such as covering depreciation, paying interest on loans, distributing dividends to shareholders, or reinvesting in the business.

Practical Applications

Gross operating surplus is a fundamental economic indicator with several practical applications across various economic analyses and policy considerations:

• National Accounts: It is a core component in the income approach to calculating Gross Domestic Product (GDP) by national statistical agencies like the Bureau of Economic Analysis (BEA) in the U.S. This provides a comprehensive overview of the nation's economic output. Data on gross operating surplus is regularly compiled and published in the National Income and Product Accounts (NIPA) tables.³
• Economic Analysis: Economists analyze trends in gross operating surplus to understand shifts in corporate profitability, the return to capital at a macroeconomic level, and the distribution of national income between labor and capital. This helps in assessing the health of the business sector.
• Policy Formulation: Governments and central banks monitor gross operating surplus as part of their assessment of overall economic conditions. This information can inform decisions related to fiscal policy, such as corporate tax rates, or contribute to considerations for monetary policy by understanding the capacity of businesses to invest and expand.
• Sectoral Analysis: Gross operating surplus can be disaggregated by industry, allowing for detailed analysis of the performance and profitability of specific sectors within an economy. This helps identify which industries are contributing most significantly to the nation's economic surplus.

Limitations and Criticisms

While gross operating surplus is a valuable macroeconomic measure, it has certain limitations and criticisms that warrant consideration:

• Distinction from Accounting Profit: Gross operating surplus differs from the "profit" typically reported in a company's financial statements. Company accounting profits, as found on an income statement, account for depreciation, interest expenses, and other non-operating income or expenses. GOS, as a national accounts concept, is gross of consumption of fixed capital and does not include financial income or expenses.¹, ² This means gross operating surplus is not directly comparable to the net profit figures seen in corporate annual reports.
• Exclusion of Unincorporated Enterprises: GOS specifically refers to the surplus generated by incorporated enterprises. For unincorporated businesses, such as sole proprietorships and partnerships, a similar concept called "gross mixed income" is used, which combines both labor and capital income because distinguishing between the two is often difficult. This distinction can complicate comparisons across different types of business structures.
• Macro vs. Micro Perspective: Gross operating surplus provides a high-level, aggregate view of the economy. It does not offer insights into the financial health or specific operational efficiency of individual companies or sectors beyond broad trends.
• Absence of Financial Flows: GOS focuses purely on the surplus from production activities. It does not capture financial transactions, investment income, or capital gains/losses, which are crucial aspects of a firm's overall financial performance and are reflected in its balance sheet.

Gross Operating Surplus vs. Operating Profit

While both gross operating surplus (GOS) and operating profit relate to a business's core activities, they originate from different accounting frameworks and serve distinct purposes. Gross operating surplus is a macroeconomic concept used in national income accounting, specifically for incorporated enterprises. It measures the surplus generated from production before accounting for the consumption of fixed capital (depreciation) and before financial transactions or taxes on income. Its primary role is to contribute to the calculation of Gross Domestic Product (GDP) by the income approach.

In contrast, operating profit, also known as earnings before interest and taxes (EBIT), is an accounting measure found on a company's income statement. It reflects a company's profit from its core operations after deducting operating expenses, including the cost of goods sold, administrative expenses, and depreciation, but before deducting interest and income taxes. Unlike GOS, operating profit is a microeconomic figure used by investors and analysts to assess the efficiency and profitability of an individual firm. The key difference lies in their scope (macro vs. micro) and their treatment of depreciation and financial items.

FAQs

What does "gross" mean in gross operating surplus?

"Gross" in gross operating surplus means that the measure does not account for the consumption of fixed capital, which is essentially the depreciation or wear and tear on physical assets like machinery and buildings. It is a measure before this cost is subtracted.

How is gross operating surplus different from a company's net profit?

Gross operating surplus is a macroeconomic concept reflecting income from production before capital consumption, financial income/expenses, or taxes on income. A company's net profit, from its income statement, is a microeconomic figure that accounts for all these factors, including depreciation, interest, and taxes, to arrive at the final profit available to shareholders.

Why is gross operating surplus important for economic analysis?

Gross operating surplus is important because it provides insight into the profitability of the corporate sector at a national level and the share of national income attributed to capital. It is a key component in calculating Gross Domestic Product by the income approach, offering a comprehensive view of a nation's economic health and economic growth.

Does gross operating surplus include government subsidies?

Yes, the calculation of gross operating surplus typically involves "taxes on production and imports (net of subsidies)." This means that subsidies received by producers are effectively added back or reduce the impact of taxes on production, influencing the final GOS figure.

Can gross operating surplus be negative?

Theoretically, gross operating surplus can be negative if the total output generated by incorporated enterprises is less than their combined costs for intermediate consumption, compensation of employees, and net taxes on production. While uncommon for an entire economy, negative GOS could occur in specific industries or during severe economic downturns.