Net income definition
/What is Net Income?
Net income is the excess of revenues over expenses. This measurement is one of the key indicators of company profitability, along with gross margin and before-tax income. There are some issues with net income that can yield misleading results, as noted below.
How to Calculate Net Income
A common calculation for net income is to subtract the cost of goods sold, administrative expenses, and income tax expense from net sales. The formula is as follows:
Net sales - Cost of goods sold - Administrative expenses - Income tax expense = Net income
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Example of Net Income
Revenues of $1,000,000 and expenses of $900,000 yield net income of $100,000. In this example, if the amount of expenses had been higher than revenues, the result would have been termed a net loss, rather than net income.
Presentation of Net Income
Net income is listed near the bottom of the income statement, after the operating income line item.
Problems with Net Income
Net income is commonly used as a measure of company performance. However, it can yield misleading results under the following circumstances:
Cash flows (a better indicator of company health) may differ significantly from net profit, due to the inclusion of noncash revenues and expenses in the compilation of the net profit figure.
Net income derived under the cash basis of accounting can vary substantially from net income derived under the accrual basis of accounting, since the first method is based on cash transactions, and the latter method records transactions irrespective of changes in cash flows.
Fraudulent or aggressive accounting practices can yield unusually large net income that does not properly reflect the underlying profitability of a business.
An undue focus on net income can mask other problems in a company, such as excessive use of working capital, declining cash balances, obsolete inventory, heavy debt usage, and so forth.
Thus, it is generally best to rely upon net income information only in conjunction with other types of information, and preferably only after the financial statements have been audited.
Gross Profit vs. Net Income
The gross profit generated by a business only subtracts the cost of goods sold from net sales; it does not include the effects of administrative expenses and income taxes. Conversely, net income includes the effects of all expenses, and so provides a more comprehensive view of the results of a business.
Terms Similar to Net Income
Net income is also known as net profit, the bottom line, or profit and loss.