What It Is:

Net income represents the amount of money remaining after all costs, depreciation, interest, taxes, and other expenses have been deducted from a company's total sales. Net income is also referred to as the bottom line, net profit, or net earnings. The formula for net income is as follows:

Total Revenues - Total Expenses = Net Income

Note that preferred stock dividends are typically included as expenses in the net income calculation, but common stock dividends are not.

How It Works/Example:

Let's assume that Company XYZ delivered the following financial results last year:

Revenue: $1,000,000
Cost of Goods Sold: $500,000
General & Administrative: $300,000
Depreciation: $100,000
Interest Expense: $5,000
Interest Income: $1,000
Taxes: $10,000
Preferred Dividends: $10,000

Using the formula and the information above, we can calculate Company XYZ's net income as follows:

$1,000,000 - $500,000 - $300,000 - $100,000 - $5,000 + $1,000 - $10,000 - $10,000 = $76,000

In this particular example, Company XYZ earned a net income of $76,000 last year.

Why It Matters:

Net income is one of the most closely followed numbers a company can produce, and it plays a part in many other financial measures. It is important to understand that net income is not a measure of how much cash a company earned during a given period. This is because the income statement, and hence net income, typically includes a host of non-cash expenses such as depreciation and amortization. It is also important to understand that changes in accounting methods can greatly influence net income figures, and in many cases these changes may have little to do with a company's actual operations.

Changes in net income are the subject of much analysis. In general, when a company's net income is negative or is fairly low, this could suggest a myriad of problems, ranging from inadequacies in customer or expense management to unfavorable accounting methods. On the other hand, some companies strive to minimize taxes and will therefore intentionally attempt to minimize their reported net income.

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 (profit margin) when comparing two different companies. Another common basis for comparison is the price/earnings (P/E) ratio, which also incorporates a company's net income into the equation.

Care should also be taken when comparing net income over time, as many companies and industries are cyclical and/or seasonal. As a result, comparisons are generally most meaningful among companies within the same industry, and the definition of a "high" or "low" net income is often best made within this context.