Net income

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    In business and accounting, net income (also total comprehensive income, net earnings, net profit, bottom line, sales profit, or credit sales) is an entity's income minus cost of goods sold, expenses, depreciation and amortization, interest, and taxes for an accounting period. [1]

    Contents

    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] It is different from gross income, which only deducts the cost of goods sold from revenue.

    For households and individuals, net income refers to the (gross) income minus taxes and other deductions (e.g. mandatory pension contributions).

    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).

    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. 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.

    Net income is usually calculated per annum, for each fiscal year. 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, & design and development costs are included. Net income can also be calculated by adding a company's operating income to non-operating income and then subtracting off taxes. [4]

    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.

    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. [5]

    Example

    Net profit on a P & L (profit and loss) account:

    1. Sales revenue = price (of product) × quantity sold
    2. Gross profit = sales revenue − cost of sales and other direct costs
    3. Operating profit = gross profit − overheads and other indirect costs
    4. EBIT (earnings before interest and taxes) = operating profit + non-operating income
    5. Pretax profit (EBT, earnings before taxes) = operating profit − one off items and redundancy payments, staff restructuring − interest payable
    6. Net profit = Pre-tax profit − tax
    7. Retained earnings = Net profit − 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 salescost of goods sold
    Gross profit percentage = [(net salescost 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 salescost of goods sold
    Operating profit = gross profit – total operating expenses
    Net profit = operating profit – taxes – interest
    Net profit = net salescost of goods soldoperating expense – taxes – interest

    See also

    Related Research Articles

    Revenue

    In accounting, revenue is the income or increase in net assets that an entity has from its normal activities. Commercial revenue may also be referred to as sales or as turnover. Some companies receive revenue from interest, royalties, or other fees. "Revenue" may refer to income in general, or it may refer to the amount, in a monetary unit, earned during a period of time, as in "Last year, Company X had revenue of $42 million". Profits or net income generally imply total revenue minus total expenses in a given period. In accounting, in the balance statement, revenue is a subsection of the Equity section and revenue increases equity, it is often referred to as the "top line" due to its position on the income statement at the very top. This is to be contrasted with the "bottom line" which denotes net income.

    In accounting, book value is the value of an asset according to its balance sheet account balance. For assets, the value is based on the original cost of the asset less any depreciation, amortization or impairment costs made against the asset. Traditionally, a company's book value is its total assets minus intangible assets and liabilities. However, in practice, depending on the source of the calculation, book value may variably include goodwill, intangible assets, or both. The value inherent in its workforce, part of the intellectual capital of a company, is always ignored. When intangible assets and goodwill are explicitly excluded, the metric is often specified to be "tangible book value".

    Cost of goods sold

    Cost of goods sold (COGS) is the carrying value of goods sold during a particular period.

    Tax deduction is a reduction of income that is able to be taxed and is commonly a result of expenses, particularly those incurred to produce additional income. Tax deductions are a form of tax incentives, along with exemptions and credits. The difference between deductions, exemptions and credits is that deductions and exemptions both reduce taxable income, while credits reduce tax.

    Income statement

    An income statement or profit and loss account is one of the financial statements of a company and shows the company's revenues and expenses during a particular period.

    Earnings before interest, taxes, depreciation and amortization

    A company's earnings before interest, taxes, depreciation, and amortization is an accounting measure calculated using a company's earnings, before interest expenses, taxes, depreciation, and amortization are subtracted, as a proxy for a company's current operating profitability.

    Cash flow statement

    In financial accounting, a cash flow statement, also known as statement of cash flows, is a financial statement that shows how changes in balance sheet accounts and income affect cash and cash equivalents, and breaks the analysis down to operating, investing, and financing activities. Essentially, the cash flow statement is concerned with the flow of cash in and out of the business. As an analytical tool, the statement of cash flows is useful in determining the short-term viability of a company, particularly its ability to pay bills. International Accounting Standard 7 is the International Accounting Standard that deals with cash flow statements.

    In corporate finance, free cash flow (FCF) or free cash flow to firm (FCFF) is a way of looking at a business's cash flow to see what is available for distribution among all the securities holders of a corporate entity. This may be useful to parties such as equity holders, debt holders, preferred stock holders, and convertible security holders when they want to see how much cash can be extracted from a company without causing issues to its operations.

    Earnings before interest and taxes

    In accounting and finance, earnings before interest and taxes (EBIT) is a measure of a firm's profit that includes all incomes and expenses except interest expenses and income tax expenses.

    Profit margin, net margin, net profit margin or net profit ratio is a measure of profitability. It is calculated by finding the net profit as a percentage of the revenue.

    In business, operating margin—also known as operating income margin, operating profit margin, EBIT margin and return on sales (ROS)—is the ratio of operating income to net sales, usually expressed in percent.

    In financial accounting, operating cash flow (OCF), cash flow provided by operations, cash flow from operating activities (CFO) or free cash flow from operations (FCFO), refers to the amount of cash a company generates from the revenues it brings in, excluding costs associated with long-term investment on capital items or investment in securities. The International Financial Reporting Standards defines operating cash flow as cash generated from operations, less taxation and interest paid, gives rise to operating cash flows. To calculate cash generated from operations, one must calculate cash generated from customers and cash paid to suppliers. The difference between the two reflects cash generated from operations.

    For households and individuals, gross income is the sum of all wages, salaries, profits, interest payments, rents, and other forms of earnings, before any deductions or taxes. It is opposed to net income, defined as the gross income minus taxes and other deductions.

    In bookkeeping, accounting, and finance, net sales are operating revenues earned by a company for selling its products or rendering its services. Also referred to as revenue, they are reported directly on the income statement as Sales or Net sales.

    In insurance, Deferred Acquisition Costs (DAC) is an asset on the balance sheet representing the deferral of the cost of acquiring new insurance contracts, thereby amortising the costs over their duration. Insurance companies face large upfront costs incurred in issuing new business, such as commissions to sales agents, underwriting, bonus interest and other acquisition expenses.

    Profit, in accounting, is an income distributed to the owner in a profitable market production process (business). Profit is a measure of profitability which is the owner's major interest in the income-formation process of market production. There are several profit measures in common use.

    In U.S. business and financial accounting, the income is generally defined by GAAP and the Financial Accounting Standards Board as: Revenues - Expenses; however, many people use it as shorthand for net income, which is the amount of money that a company earns after covering all of its costs as well as taxes.

    Non-operating income

    Non-operating income, in accounting and finance, is gains or losses from sources not related to the typical activities of the business or organization. Non-operating income can include gains or losses from investments, property or asset sales, currency exchange, and other atypical gains or losses. Non-operating income is generally not recurring and is therefore usually excluded or considered separately when evaluating performance over a period of time.

    Financial ratio

    A financial ratio or accounting ratio is a relative magnitude of two selected numerical values taken from an enterprise's financial statements. Often used in accounting, there are many standard ratios used to try to evaluate the overall financial condition of a corporation or other organization. Financial ratios may be used by managers within a firm, by current and potential shareholders (owners) of a firm, and by a firm's creditors. Financial analysts use financial ratios to compare the strengths and weaknesses in various companies. If shares in a company are traded in a financial market, the market price of the shares is used in certain financial ratios.

    References

    1. "IAS 1 Presentation of Financial Statements" (PDF). IFRS Foundation. 2012. Retrieved April 14, 2012.
    2. Stickney, et al. (2009) Financial Accounting: An Introduction to Concepts, Methods, and Uses. Cengage Learning
    3. Needles, et al. (2010) Financial Accounting. Cengage Learning.
    4. "Net Income Formula". New Business Playbook. Archived from the original on 2013-10-19.
    5. 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.