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    Tuesday
    Jan152013

    What is the net income formula?

    The net income formula yields the residual amount of gain or loss remaining after expenses are deducted from revenue. The results of the net income formula are closely watched, since they reveal whether a business is likely to be a viable operating entity.

    The net income formula appears near the bottom of the income statement. The following table, which sets forth the net income formula, itemizes the general types of expenses that are deducted from revenue in order to arrive at net income:

     + Revenue
     -
    Cost of goods sold
     = Gross margin
     - Operating expenses
     - Gains and losses
     - Other revenues and expenses
     - Items that are unusual or infrequent
     = Income from continuing operations
     +/- Income/loss from the operations of a discontinued component
     +/- Gain /loss from disposal of a discontinued component
     +/- Extraordinary items
     = Net income/loss


    Note that other comprehensive income is a separate category of unrealized gains and losses that is not included in the derivation of net income. Instead, other comprehensive income is placed after the net income figure in the income statement.

    The results of the net income formula may not be reliable, since management may fraudulently twist the rules of accrual basis accounting to modify the reported profit. This is particularly common when management is attempting to reach a profit figure that will trigger bonus payments, or when there is outside pressure from the investment community to report high profits.

    The net income formula is also relatively easily altered under the cash basis of accounting by altering the recordation date of cash receipts, as well as by altering the dates on which payables are paid.

    The amount of net income can be verified to some extent through a close examination of the statement of cash flows, which shows the sources and uses of cash.

    Similar Terms

    The net income formula is also known as the net income equation.

    Related Topics

    What are pro forma earnings?
    What is EBITDA?
    What is other comprehensive income?
    What is segment margin?
    What is the operating profit margin?

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