What Is NOI (Net Operating Income) and How to Calculate It?

If you’ve ever wondered how savvy entrepreneurs or investors gauge the potential profitability of a business, you’re in for a treat. 

Today, we’re exploring one key metric that can make or break an investment decision: Net Operating Income (NOI). Whether you’re a seasoned investor or a newcomer, doola Bookkeeping software can help you automate these calculations to demystify your NOI. 

But first, we will explain what is NOI and equip you with everything you need to know, including its definition, significance, and how to calculate it like a pro. 

Let’s doola it!

What Is NOI or Net Operating Income?

Net Operating Income (NOI) represents the income generated from core business activities after deducting all operating expenses, excluding financing costs and taxes. This metric focuses on the revenue produced through the entity’s primary business functions, considering the costs required to maintain those operations. 

NOI is usually used in real estate to assess how much you stand to gain from an asset after subtracting what it takes to maintain that asset. 

It’s used to value commercial real estate or other income-generating property assets that require routine maintenance and upkeep.

NOI can be calculated monthly or annually; however, annual calculations are more common as they provide a broader overview of the property’s performance over time. 

Why Is NOI Important?

Knowing your NOI can help investors make informed decisions about potential purchases or current investments. But wait, there’s more:

• Evaluating Return on Investment (ROI): You can determine the percentage ROI your rental property has provided by comparing your net operating income against your initial investment cost (down payment + closing costs).

• Understanding Market Value: Potential buyers often use NOI to determine whether an asking price aligns with market standards for similar properties.

• Predicting Cash Flow: NOI accurately indicates the amount of cash you can expect to profit from your rental property each year. 

• Find Ways to Reduce Costs: NOI can help you evaluate your rental rates and make adjustments if necessary. 

• Raise Capital or Investments: A higher NOI means lower risk for lenders because it demonstrates that an investment has enough cash flow to cover mortgage payments.

How to Calculate Net Operating Income (NOI)

To calculate NOI, you can use the formula:

Net Operating Income (NOI) = Total Revenue – Operating Expenses

To calculate NOI, 3 key components need to be considered: potential rental income, operating expenses, and vacancy rate.

It’s important to note that NOI does not take into account any financing costs, such as mortgage payments or interest. 

While these expenses may affect cash flow and, ultimately, the property’s profitability, they are not considered in NOI calculations.

An Example of Net Operating Income (NOI) Calculation

To calculate NOI, you must examine every bit of income you take in at the property and subtract all the costs it takes to keep the property up and running. 

Let’s look at a specific example in more detail:

Let’s say you own a multi-family property with 6 units, each rented out at $1,500 per month. The annual rental income for this property would be $108,000 ($1,500 x 6 units x 12 months). 

However, to calculate the NOI accurately, we need to account for all of the expenses associated with owning and operating the property.

Let’s assume that the annual expenses for this property include:

• Property taxes: $10,000

• Insurance: $5,000

• Maintenance and repairs: $8,000

• Utilities (water and electricity): $6,000

• Property management fees: $9,000

To calculate the NOI for this property, we first need to subtract all of these expenses from the annual rental income. This would look like:

Total Rental Income – Operating Expenses = NOI

$108,000 – ($10,000 + $5,000 +$8,000 +$6,000 +$9 ,000) = $70,000 

In our example, an NOI of $70,000 means that after all operating expenses are paid, $70,000 is available to cover debt payments and still generate profit.

NOI vs. Other Financial Metrics

Now that we’ve answered and explained what is NOI, it’s also important to note that NOI should not be viewed in isolation. 

Here’s how NOI compares to other financial metrics, such as EBITDA, cash flow, and net income, to provide further insights into a property’s profitability.

1. NOI vs. EBITDA

One key difference between these two metrics is that NOI takes into account the actual cash inflows from rent payments and other operating revenues.

On the other hand, EBITDA does not factor in rent collection as it only considers when revenue is recognized on an accrual basis.

2. NOI vs. Cash Flow

Unlike NOI, which focuses on operational income exclusively, cash flow considers all sources of cash inflow and outflow associated with an investment.

However, the main difference between NOI and cash flow is their treatment of non-cash charges such as depreciation. 

While these charges are factored into calculating NOI since they impact a property’s operating expenses, they are not included in cash flow calculations.

3. NOI vs. Net Income

The key difference between NOI and net income is their tax treatment. While NOI is calculated pre-tax, net income takes into account any taxes paid on a property’s income or gain.

This provides a more accurate representation of a property’s income-generating potential and allows for seamless and on-time tax filing. 

On the other hand, net income reflects an investment’s actual profitability after accounting for taxes and can be useful for assessing its after-tax returns.

How to Improve NOI in an Ecommerce Business

In order to improve NOI in an ecommerce business, 3 main strategies can be implemented. 

By effectively implementing these tactics, ecommerce businesses can increase their NOI and ultimately become more profitable.

📌 Reduce Operating Expenses Without Hurting Growth

One of the most effective ways to improve NOI is to find ways to decrease costs while maintaining or even increasing sales. 

One way to achieve this is through renegotiating contracts with suppliers for better rates, optimizing inventory management to reduce waste and excess stock, and streamlining internal processes to eliminate unnecessary spending.

For example, switching to more efficient back-office tools like doola Bookkeeping with flexible pricing can be more cost-effective than hiring additional staff.

📌 Increase Revenue Streams

The second strategy for improving NOI is by diversifying revenue streams. This means expanding beyond traditional product sales and exploring other avenues for generating income. 

For ecommerce businesses, this could include offering additional services such as subscription plans or upselling related products at checkout.

Businesses can also consider partnering with complementary brands for cross-promotion opportunities or creating affiliate marketing programs where they earn a commission on sales made through referral links.

📌 Optimize Pricing and Profit Margins

To maximize profits, ecommerce businesses should also focus on setting appropriate profit margins based on industry standards while remaining competitive within the market. 

It may also be beneficial to implement dynamic pricing techniques which allow for adjustments based on demand levels.

You can also conduct competitor analysis to stay informed about prevailing market prices and make informed decisions about your own pricing strategies.

Common Mistakes in NOI Calculation

When it comes to calculating net operating income (NOI), there are a few common mistakes that can easily trip up even the most seasoned real estate investors. 

These mistakes may seem minor, but they can result in significant errors in the final NOI calculation.

Not Including All Potential Income Sources

When calculating NOI, you need to consider all income sources related to the property, such as rental income from tenants, parking fees, laundry revenue, and any other ancillary income.

Excluding Vacancy Losses

Another important factor that often gets overlooked is vacancy losses. When determining your NOI, a vacant unit means no rental revenue for that particular period. 

Many investors forget to account for this expense and end up with an inflated estimation of their NOI.

Forgetting About Operating Expenses

In addition to considering potential income sources, it’s crucial to include all operating expenses, such as insurance premiums, property taxes, repairs and maintenance costs, utilities fees, etc.

Ignoring Capital Expenditures

Similar to operating expenses, capital expenditures (CapEx) should also be factored into your calculations accurately. 

CapEx refers to substantial investments made in improving or replacing a property’s major components over time.

For example, HVAC systems or roofing can significantly impact a property’s value and expenses over time.

Inconsistent Time Frames 

One mistake novice investors often make is using inconsistent time frames when performing their calculations, which can lead to false results or discrepancies in their projections. 

Make sure you use the same period for both your income and expenses when calculating NOI, typically annual or monthly.

Simplify NOI Calculations With doola Bookkeeping

With doola Bookkeeping, you no longer have to spend hours compiling data and performing complex calculations manually. It integrates all your financial data from various sources, such as bank accounts and credit cards, into one central dashboard. 

This eliminates the need for manual data entry or switching between different spreadsheets. It also reduces the chances of human error, ensuring accurate results every time.

So, in just a few clicks, you can obtain accurate and detailed reports on your net operating income for any given period. The software takes into account all relevant expenses such as vacancies, repairs/maintenance costs, insurance premiums, property taxes, and more.

Additionally, doola allows you to customize your NOI calculations by including or excluding certain expenses depending on your business model and requirements.

Book a demo with us for seamless NOI calculations without sacrificing accuracy or efficiency.

FAQs

What expenses are included in NOI?

NOI calculation requires all operating expenses needed to maintain and manage the property. These operating expenses typically include:

1. Property taxes

2. Insurance premiums

3. Management fees

4. Maintenance and repair costs

5. Utilities such as water, electricity, and gas.

6. Landscaping and snow removal services.

7. Advertising and marketing fees.

8. Other operational costs related to running the property.

Why is NOI important for investors?

NOI allows investors to evaluate a property’s profitability by determining its net income after deducting necessary operating costs. 

Investors can also compare a property’s NOI with similar properties in the market, protect themselves from overpaying for a property or set realistic rental rates that attract potential tenants.

How is NOI different from gross income?

Gross income refers to all revenues generated by the property before any deductions. On the other hand, NOI takes into account all operating expenses and excludes mortgage payments and income taxes. 

This provides a more accurate picture of the property’s financial performance by considering only the costs associated with running the property.