What is net income? Everything you need to know about net income

Rebecca Cattlin
By :  ,  Financial Writer

What is net income?

Net income is a measure of the exact money a business has brought in after costs have been deducted from its revenue. It’s shown at the end of a company’s income statement, which is why it’s also known as the ‘bottom line’.

Net income is used by investors to determine whether profits exceed the expenses of an organisation – or how much profit a company can keep and distribute back to its shareholders.

A company that sees net profits each quarter is more appealing as an investment opportunity, especially if it’s a company that pays dividends. A net loss doesn’t always turn investors off, but it will need growth potential to attract investors.

 

How to calculate net income

Net income is calculated by subtracting costs and fees – such as taxes – from revenue. The formula for calculating net income is:

Net income = revenue – expenses

Expenses can vary from company to company, but generally, they include operating costs, interest on debts and loans, administrative expenses, income taxes, and depreciation of things like company equipment.

 

Is net income the same as profit?

Net income is often seen as synonymous with profit because net income represents the ultimate measure of a company’s profitability.

However, profit is a widely used term that can refer to a company’s income at any point on the statement and doesn’t necessarily have all the necessary costs deducted.

 

What is the difference between gross income and net income?

Gross income is the money a company has made after only subtracting production costs from its revenue. By contrast, net income considers production costs along with other costs, such as taxes and payroll.

Production or operating costs that subtract from gross income include the cost of buying materials and equipment, paying for labour, utility costs, and shipping expenses. An easy way to determine which costs are subtracted from gross income is to look at whether they are fixed costs.

Fixed costs usually stay the same each earnings period. This includes things like staff salaries, rent, and insurance. Both gross income and net income are found on a company’s income statement.

Gross income, also referred to as gross profit, is found at the top of the statement; net income is at the bottom. This placement makes it easy for readers to track the expenses and costs as they are subtracted from the gross income and total the net income.

If a company is just using the term ‘profit’ in their press releases, it’s important to understand which part of the income statement they’re talking about – gross income or net income.

 

How to find a company's net income on a balance sheet

Net income is not shown outright on a company’s balance sheet, but it can be calculated using the formula above. Alternatively, you can find net income on the company’s income statement.

The income statement is a similar document that shows a company’s financial picture over a past period like a fiscal quarter or year. Net income is often referred to as the ‘bottom line’ because it is located at the bottom of the document.

Sometimes net income is specified as Net Income After Taxes (NIAT) on a company’s annual or quarterly financial report. Often net income and NIAT are used interchangeably, so it is most important to mention taxes when talking about net income before taxes.

Looking at pre-tax net income can help compare two similar companies that are subject to different taxation. This can occur if two companies in the same industry are in different states or countries.

 

Can net income be negative?

Net income can be negative. If a company’s expenses cost more than the revenue it made in that period, its net income would be negative.

But that doesn’t mean they aren’t considered profitable. Companies may have negative net incomes if their revenue operates on a cyclical schedule, meaning they make their profits during one but not all of their quarterly periods.

For example, an agricultural firm may report a negative net income during one or two quarters when they aren’t selling as many goods due to the harvest cycle. However, they can still have a positive yearly net income if they make enough money during the other two quarters to overcompensate for their losses.

A growing company may also intentionally operate with a negative net income. Start-ups often operate with a negative net income when beginning as they concentrate on collecting investments as opposed to focusing solely on profitability. Some start-ups don’t aim for positive net incomes until years later.

However, when the expenses are more than the revenue, the company is more likely to make up the difference through loans. And a huge pile of debt can lead investors to be more cautious about buying the company’s stock.

 

How does net income impact a company's share price?

Net income can impact a company’s share price, but it is not the only factor.

A rise in net income can indicate both a financially healthy business and positive economic conditions. Either of these factors can raise share prices.

However, a company can report positive growth in net income and still have its share price drop. This often happens when traders determine external factors, such as regulatory actions, are more important than the company’s current positive net income.

Another key factor is the difference between analysts’ expectations of net income figures and the actual reported numbers. If there is a huge difference, investors can be ‘surprised’, which may result in share price volatility.

 

Do dividends affect a company's net income?

Neither stock nor cash dividends are listed as company expenses and do not affect net income. Instead, dividends are paid from a company’s retained earnings accounts.

When cash dividends are paid out from a retained earnings account, the change is shown as a reduction in shareholder equity. This reduction in equity occurs because paying cash dividends reduces a company’s liquid assets.

Stock dividends are awarded to shareholders in the form of more shares. Unlike cash dividends, these do not appear on a company’s balance sheet. Instead, these dividends reallocate retained earnings to common stock. These dividend payments are done after calculating net income, once that money has been added to the company’s retained earnings.

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