Net income
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In business and accounting, net income (total comprehensive income, net earnings, net profit, bottom line, gross profit[citation needed], gross margin, sales profit, or credit sales) is an entity's income minus cost of goods sold, expenses and taxes for an accounting period.[1] It is computed as the residual of all revenues and gains over all expenses and losses for the period,[2] and has also been defined as the net increase in shareholders' equity that results from a company's operations.[3] In the context of the presentation of financial statements, the IFRS Foundation defines net income as synonymous with profit and loss.[1] The difference between revenue and the cost of making a product or providing a service, before deducting overheads, payroll, taxation, and interest payments. This is different from operating profit (earnings before interest and taxes).[4]
A common synonym for net profit when discussing financial statements (which include a balance sheet and an income statement) is the bottom line. This term results from the traditional appearance of an income statement which shows all allocated revenues and expenses over a specified time period with the resulting summation on the bottom line of the report.
In simplistic terms, net profit is the money left over after paying all the expenses of an endeavor. In practice this can get very complex in large organizations or endeavors. The bookkeeper or accountant must itemise and allocate revenues and expenses properly to the specific working scope and context in which the term is applied.
Definitions of the term can, however, vary between the UK and US. In the US, net profit is often associated with net income or profit after tax (see table below).
The net profit margin percentage is a related ratio. This figure is calculated by dividing net profit by revenue or turnover, and it represents profitability, as a percentage.
It is a measure of the profitability of a venture after accounting for all costs and taxes. It is the actual profit, and includes the operating expenses that are excluded from gross profit.
Net income is usually calculated per annum, for each fiscal year. It is the same as net profit but a distinct accounting concept from profit, i.e. the amount of money the company has made before its company-specific deductions are subtracted. Net income can also be calculated by adding a company's operating income to non-operating income and then subtracting off taxes.[5]
"How does a company decide whether it is successful or not? Probably the most common way is to look at the net profits of the business. Given that companies are collections of projects and markets, individual areas can be judged on how successful they are at adding to the corporate net profit."[6]
Definition
Net income can be distributed among holders of common stock as a dividend or held by the firm as an addition to retained earnings. As profit and earnings are used synonymously for income (also depending on UK and US usage), net earnings and net profit are commonly found as synonyms for net income. Often, the term income is substituted for net income, yet this is not preferred due to the possible ambiguity. Net income is informally called the bottom line because it is typically found on the last line of a company's income statement (a related term is top line, meaning revenue, which forms the first line of the account statement).
The items deducted will typically include tax expense, financing expense (interest expense), and minority interest. Likewise, preferred stock dividends will be subtracted too, though they are not an expense. For a merchandising company, subtracted costs may be the cost of goods sold, sales discounts, and sales returns and allowances. For a product company advertising, manufacturing, and design and development costs are included.
Cost of goods sold is calculated differently for a merchandising business than for a manufacturer.
An equation for net income
Net profit: To calculate net profit for a venture (such as a company, division, or project), subtract all costs, including a fair share of total corporate overheads, from the gross revenues or turnover.
- Net profit = sales revenue − total costs
Net profit is a measure of the fundamental profitability of the venture. "It is the revenues of the activity less the costs of the activity. The main complication is . . . when needs to be allocated" across ventures. "Almost by definition, overheads are costs that cannot be directly tied to any specific" project, product, or division. "The classic example would be the cost of headquarters staff." "Although it is theoretically possible to calculate profits for any sub-(venture), such as a product or region, often the calculations are rendered suspect by the need to allocate overhead costs." Because overhead costs generally don’t come in neat packages, their allocation across ventures is not an exact science.[7]
Example
Here is how you reach net profit on a P&L (Profit & Loss) account:
- Sales revenue = price (of product) × quantity sold
- Gross profit = sales revenue − cost of sales and other direct costs
- Operating profit = gross profit − overheads and other indirect costs
- EBIT (earnings before interest and taxes) = operating profit + non-operating income
- Pretax profit (EBT, earnings before taxes) = operating profit − one off items and redundancy payments, staff restructuring − interest payable
- Net profit = Pre-tax profit − tax
- Retained earnings = Profit after tax − dividends
Another equation to calculate net income:
Net sales (revenue) - Cost of goods sold = Gross profit - SG&A expenses (combined costs of operating the company) - Research and development (R&D) = Earnings before interest, taxes, depreciation and amortization (EBITDA) - Depreciation and amortization = Earnings before interest and taxes (EBIT) - Interest expense (cost of borrowing money) = Earnings before taxes (EBT) - Tax expense = Net income (EAT)
Another equation to calculate net income:
- Net sales = gross sales – (customer discounts + returns + allowances)
- Gross profit = net sales – cost of goods sold
- Gross profit percentage = [(net sales – cost of goods sold)/net sales] × 100%.
- Operating profit = gross profit – total operating expenses
- Net income = operating profit – taxes – interest
Other terms
- Net sales = gross sales – (customer discounts, returns, and allowances)
- Gross profit = net sales – cost of goods sold
- Operating profit = gross profit – total operating expenses
- Net profit = operating profit – taxes – interest
- Net profit = net sales – cost of goods sold – operating expense – taxes – interest
See also
- Dividend
- Economic value added
- Gross income
- Income statement
- Liquidating dividend
- Net income per employee
- Operating income
- Operating Income Before Depreciation and Amortization
- Opportunity cost
- Profit (accounting)
- Revenue
- Cost of goods sold
- Profit margin (the ratio of net income to net sales)
- Gross margin (the difference between the sales and the production costs)
References
- ^ a b "IAS 1 Presentation of Financial Statements" (PDF). IFRS Foundation. 2012. Retrieved April 14, 2012.
- ^ Stickney, et al. (2009) Financial Accounting: An Introduction to Concepts, Methods, and Uses. Cengage Learning.
- ^ Needles, et al. (2010) Financial Accounting. Cengage Learning.
- ^ Horngren, Charles (2011). Accounting, 9th Edition. Upper Saddle River, New Jersey 07458: Prentice Hall. ISBN 0132569051.
{{cite book}}: CS1 maint: location (link) - ^ "Net Income Formula". New Business Playbook. Archived from the original on 2013-10-19.
{{cite web}}: Unknown parameter|deadurl=ignored (|url-status=suggested) (help) - ^ Farris, Paul W.; Neil T. Bendle; Phillip E. Pfeifer; David J. Reibstein (2010). Marketing Metrics: The Definitive Guide to Measuring Marketing Performance. Upper Saddle River, New Jersey: Pearson Education, Inc. ISBN 0137058292. Content from this book used in this article has been licensed for modification and reuse under the Creative Commons Attribute Share Alike 3.0 and Gnu Free Documentation licenses. See talk. The Marketing Accountability Standards Board (MASB) endorses the definitions, purposes, and constructs of classes of measures that appear in Marketing Metrics as part of its ongoing Common Language in Marketing Project.
- ^ Farris, Paul W.; Neil T. Bendle; Phillip E. Pfeifer; David J. Reibstein (2010). Marketing Metrics: The Definitive Guide to Measuring Marketing Performance. Upper Saddle River, New Jersey: Pearson Education, Inc. ISBN 0137058292. Content from this book used in this article has been licensed for modification and reuse under the Creative Commons Attribute Share Alike 3.0 and Gnu Free Documentation licenses. See talk. The Marketing Accountability Standards Board (MASB) endorses the definitions, purposes, and constructs of classes of measures that appear in Marketing Metrics as part of its ongoing Common Language in Marketing Project.