Net income formula

The net income formula yields the residual amount of profit or loss remaining after all expenses are deducted from revenue. The results of this formula are closely watched, since they reveal whether a business is likely to be a viable operating entity. When there is no ongoing trend of positive net income, investors will sell off their shares, resulting in a long-term decline in the stock price.

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
 = 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 reverse situation can also occur, where the net profit figure is artificially reduced in order to avoid paying income taxes.

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 Courses

Business Ratios Guidebook 
Financial Analysis 
The Interpretation of Financial Statements