Net income

Net income is the amount of profit an entity reports after recognized expenses and losses are deducted from its revenues and gains for a particular accounting period. When the result is negative, it is generally described as a net loss.

The U.S. Securities and Exchange Commission describes net income or loss as the profit an entity made or loss it incurred after subtracting expenses from revenues and gains during a specific period. Investor.gov similarly defines net income as the profit remaining after expenses and taxes have been deducted from revenue.

Net income is a central performance measure, but it should be interpreted together with cash flow, the balance sheet, accounting policies, and the notes to the financial statements.

Basic calculation

A simplified expression is:

<math>\text{Net income} = \text{Revenue and gains} - \text{Expenses and losses}</math>

A business-oriented calculation may be presented as:

<math>

\text{Net income} = \text{Revenue} - \text{Operating expenses} - \text{Interest} - \text{Taxes} \pm \text{Other items} </math>

The actual calculation depends on the applicable accounting rules and the organization's transactions.

Items that can affect net income include:

• sales or service revenue;
• cost of goods sold;
• employee compensation;
• rent and occupancy costs;
• depreciation and amortization;
• interest income and expense;
• gains or losses from asset sales;
• impairment charges;
• restructuring costs;
• income-tax expense;
• results from discontinued operations when separately presented.

Income statement

Net income is normally reported near the bottom of the income statement, which may also be called a statement of earnings, statement of operations, or statement of profit and loss.

The SEC explains that an income statement shows how much money a company earned and spent during a period of time.

For a public company, audited annual financial statements appear in the Form 10-K, while interim financial statements generally appear in Form 10-Q filings. These reports also include notes that explain accounting policies, estimates, risks, commitments, and the composition of important line items.

Example

Assume a company reports the following for one year:

Item	Amount
Revenue	$1,000,000
Cost of goods sold	$450,000
Operating expenses	$300,000
Interest expense	$40,000
Income-tax expense	$50,000

The calculation would be:

<math>

\$1{,}000{,}000 - \$450{,}000 - \$300{,}000 - \$40{,}000 - \$50{,}000 = \$160{,}000 </math>

The company would report $160,000 of net income, assuming no additional gains, losses, or adjustments.

Gross profit, operating income, and net income

Net income should be distinguished from other levels of earnings.

Gross profit generally equals revenue minus the direct cost of goods or services sold.

Operating income generally reflects revenue minus costs associated with core operating activities. Its composition depends on the reporting framework and presentation used by the company.

Income before taxes reflects profit before income-tax expense.

Net income incorporates taxes and other applicable items recognized for the period.

These measures answer different questions. Gross profit focuses on production or service economics, operating income focuses more closely on operations, and net income presents the final accounting result attributable to the period.

Net income and comprehensive income

Net income is not always identical to comprehensive income. Certain changes in assets, liabilities, or equity may initially be reported outside net income in other comprehensive income.

Examples can include qualifying foreign-currency translation adjustments, certain pension-related changes, and changes in the value of particular financial instruments. The treatment depends on the relevant accounting standard.

The FASB conceptual framework discusses net income, other comprehensive income, and comprehensive income as distinct but related presentation concepts.

Net income and cash flow

Net income is calculated using accrual accounting. Revenue can be recognized before cash is collected, and expenses can be recognized before or after cash is paid.

As a result, net income is not the same as net cash generated by operating activities.

Differences can arise from:

• accounts receivable;
• inventory purchases;
• unpaid expenses;
• depreciation and amortization;
• deferred taxes;
• noncash compensation;
• asset gains and losses;
• provisions and estimates.

The statement of cash flows commonly begins with net income under the indirect method and then adjusts for noncash items and working-capital changes.

Net income and retained earnings

For a corporation, net income generally increases retained earnings before dividends and certain other adjustments. A net loss generally reduces retained earnings.

A simplified relationship is:

<math>

\text{Ending retained earnings} = \text{Beginning retained earnings} + \text{Net income} - \text{Dividends} </math>

This relationship links the income statement to shareholders' equity on the balance sheet.

Earnings per share

Public companies commonly use net income or income available to common shareholders when calculating earnings per share.

Basic and diluted earnings per share can differ because diluted earnings per share reflects the potential effect of options, convertible securities, and other instruments that could increase the number of common shares.

The notes to the financial statements normally explain the calculation and any excluded antidilutive instruments.

Uses

Net income is used to evaluate:

• profitability;
• performance across accounting periods;
• profit margins;
• earnings per share;
• dividend-paying capacity;
• debt-covenant compliance;
• management performance;
• valuation ratios;
• tax and regulatory results.

Comparisons are most useful when accounting policies, business conditions, capital structures, and reporting periods are understood.

Limitations

Net income is not a complete measure of business performance.

It can be affected by:

• accounting estimates;
• depreciation methods;
• inventory-cost assumptions;
• impairment decisions;
• tax rules;
• one-time gains or losses;
• acquisition accounting;
• changes in accounting policy;
• foreign-exchange movements;
• noncash expenses;
• management judgment.

A company can report positive net income while producing weak operating cash flow, or report a net loss while generating cash because of noncash expenses or timing differences.

Analysts therefore examine net income together with revenue quality, margins, operating cash flow, free cash flow, debt, liquidity, and the financial-statement notes.

See also

• Revenue
• Expense
• Asset
• Equity (finance)
• Earnings before interest and taxes
• Cash flow
• Income statement
• Earnings per share