Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail
Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

Net Income

What it is:

Net income represents the amount of money remaining after all operating expenses, interest, taxes and preferred stock dividends (but not common stock dividends) have been deducted from a company's total revenue

How it works (Example):

Net income is also referred to as the bottom line, net profit or net earnings. The formula for net income is as follows:

Total Revenue - Total Expenses = Net Income

Net income is found on the last line of the income statement, which is why it's often referred to as the bottom line. Let's look at a hypothetical income statement for Company XYZ:

By using the formula we can see that:

Net Income = $100,000 - $20,000 - $30,000 - $10,000 - $10,000 = $30,000

Why it Matters:

Net income is one of the most closely followed numbers in finance, and it plays a large role in ratio analysis and financial statement analysis. Shareholders look at net income closely because it is the main source of compensation to shareholders of the company (via dividends and share buybacks), and if a company cannot generate enough profit to adequately compensate owners, the value of shares will plummet. Conversely, if a company is healthy and growing, higher stock prices will reflect the increased availability of profits.

[InvestingAnswers Feature: Financial Statement Analysis For Beginners]

One of the most important concepts to understand is that net income is not a measure of how much cash a company earned during a given period. This is because the income statement includes a lot of non-cash expenses such as depreciation and amortization. To learn about how much cash a company generates, you need to examine the cash flow statement (click here to read 10 Things to Know About Every Cash Flow Statement).

Changes in net income are endlessly scrutinized. In general, when a company's net income is low or negative, a myriad of problems could be to blame, ranging from decreasing sales to poor customer experience to inadequate expense management.

Net income varies greatly from company to company and from industry to industry. Because net income is measured in dollars and companies vary in size, it is often more appropriate to consider net income as a percentage of sales, known as "profit margin." Another common ratio is the price-to-earnings (P/E) ratio, which tells investors how much they are paying (the stock's price) for each dollar of net income the company is able to generate.

If you'd like to read more in-depth information about using net income and other income statement line items, check out the following:

Income Statement definition -- Learn about this all-important financial statement used to calculate profitability.

Operating Income definition -- Learn how operating income is related to net income.

Price-to-Earnings Ratio definition -- Learn how to calculate and use the P/E ratio, one of the most used ratios in investing.

Financial Statement Analysis: The Income Statement -- Learn the most important components of the income statement and how to use them to determine a company's profitability.

How to Use Margin Analysis as an Investment Tool -- Learn how to use the three most common profit margin ratios to find the best investments.

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