Net Income
The amount that is calculated as Sales minus Cost of Goods Sold, Interest, Taxes, Depreciation & Amortization, and other expenses for a given accounting period.
Updated:
April 4, 2023In accounting, net income is calculated as sales minus the cost of goods sold, interest, taxes, depreciation and amortization, and other expenses for a given accounting period.
Due to its usual location on the last line of an organization's income statement, it is commonly termed the bottom line.
Three names are frequently used interchangeably to refer to the bottom line of an income statement for a business, including:
- Net income,
- Net earnings, and
- Net Profit
For those unfamiliar with finance and accounting, the meaning of all three terms can be a bit confusing, but nevertheless, they are the same.
Net income can either be added to retained earnings by the company, given as a dividend to ordinary stockholders, or split between the two options. Net earnings and net profit are frequently used as synonyms for it because profit and earnings are used interchangeably for income.
It can also be referred to as the net growth in shareholders' equity due to a company's operations. It's distinct from the gross income, which is the result of subtracting the cost of products sold from the revenue obtained from the sales.
For families and individuals, the net income is defined as (gross) income less any applicable deductions and taxes-for example, mandatory pension contributions.
Businesses determine their earnings per share using net income.
We can also calculate FCFE (Free cash flow to equity) from net income. After all debts are paid, a company's free cash flow to equity (FCFE) ratio shows how much money is left over for distribution to shareholders.
When a company has managed to increase its net income over time, investors will want to purchase its outstanding shares of stock, which will lead to an increase in its stock price. Therefore, assuming all other factors are equal, a greater EPS often results in a high stock price.
Calculation of Net income
Typically, net income (NI) is calculated annually for each fiscal year by taking the organization's total revenue as a first step.
From the total revenue, we then deduct the following:
- Tax expense: Any sum that a person or company owes to the government in taxes is considered a tax expense.
- Financing expense: The cost, interest, and other fees associated with borrowing money to construct or purchase assets are referred to as financing costs, sometimes known as the cost of finances.
- Minority interest: The percentage of a subsidiary corporation's equity that the parent company does not own is known as the minority interest.
- Stock dividends: A common stock dividend is a payment made from the company's profits to holders of its common stock.
- Cost of goods sold: When a company sells some of its products, the direct costs related to the production of these products is known as the COGS.
- Sales discounts: A sales discount is a price decrease that the seller offers in exchange for the buyer paying the vendor in full and on time.
- Sales returns: A sales return is something the buyer sends back to the vendor for a full refund.
Other elements may include Allowances, Cost of manufacturing, and Cost of advertising/design/development.
It can also be calculated using the following formula:
NI = Pre-Tax income - Tax expense
The NI a business earns before taxes are deducted or taken into account is referred to as pretax income, earnings before taxes, or pretax earnings.
Operating and non-operating income can be combined to calculate the net income by deducting taxes.
Like other accounting measurements, it can be manipulated using techniques like expenditure concealment. Therefore, investors should examine the accuracy of the methods used to calculate the taxable income and NI before deciding to invest.
Net income Vs. Cash flow
The company's economic profit or cash flow is not reflected in its net income, as it consists of several non-cash costs, including stock-based compensation, depreciation, and amortization.
Thus, the quantity of cash flow that a corporation produced during the pertinent time is not equal to its net income.
A cash flow (CF) chart displays the inflows (payments) and outflows (receipts) of cash during a specific time period. It shows the sources and applications of cash during a particular period.
Additionally, it analyzes the reasons for changes in the balance of cash between the two balance sheet dates.
To arrive at cash flow for evaluating a company, financial analysts take tremendous measures to remove all of the accounting principles.
NI is used to decide the earnings per share and the profits. Whereas cash flow is used to decide the money position and dissolvability, working capital, and management proficiency.
When compared to cash flows, net profits are much easier to control.
Net income after Tax
Net income after tax (NIAT) is an accounting term that describes a company's profitability after deducting all necessary taxes. It is the profit of a business after deducting all taxes, expenses, and other liabilities.
Net income after tax is considered the company's bottom line, as found at the bottom of the income statement. Therefore, it is one of the most important figures to analyze once looking into a company's financial statements.
After-tax income can be referred to as a business's gross income minus taxes. These taxes include federal, provincial, withholding, state, and local taxes such as sales and property taxes.
Individual taxpayers in the US file Form 1040 with the IRS to record their yearly income. There isn't a line for NI on this form. Instead, it provides spaces for taxable income, adjusted gross income (AGI), and gross income to be entered.
Taxpayers deduct some income sources like Social Security benefits and permissible deductions like student loan interest after calculating their gross income. Therefore, their AGI makes a difference.
Although they are occasionally used synonymously, NI and AGI are two distinct concepts. The taxpayer calculates their taxable income by deducting standard or itemized deductions from their AGI.
The individual's Net income, as previously indicated, accounts for the difference between taxable income and income tax; however, this amount is not noted on individual tax returns.
Net income Vs. Gross profit
Gross profit and NI are every business's two most important profitability indicators. Gross profit can be regarded as the cash or profit still available after production costs are removed from sales.
Gross profit is commonly referred to as gross income. On the other hand, NI is the amount of profit left over after all expenditures and expenses have been reduced from the revenue.
As stated earlier, investors can use the net profit to evaluate a company's performance by assessing overall profitability.
Gross profit is calculated by deducting the cost of goods sold, sometimes mentioned as COGS, from the sales.
The cost of goods sold (COGS) is an expense account listed in the income statement of merchandising companies. It includes everything a business pays to produce the goods sold in a specific period.
It involves all the direct costs the business incurs to produce the goods it sells. These costs include the raw materials and labor used in the production process, but it can also include other specific overhead costs.
NI can be calculated by deducting operating expenses, other expenses, taxes, and interest on the debt from the gross profit.
Net income Vs. Operating profit
Both profit indicators determine a company's profitability, although they differ significantly.
Operating profit, also known as operating income, is the amount left over after operating costs are deducted from gross profit. All operating expenses, including those considered in the gross profit calculation, are included in the operating profit, which extends the profitability statistic.
After all, costs have been deducted, operating profit displays a company's earnings, excluding the cost of debt, taxes, and some one-time expenses. It is also referred to as earnings before interest and taxes (EBIT). An organization's earning potential in relation to revenues from continuing activities is represented by operating profit.
Contrarily, NI is the profit still left over after all expenses made during the time have been deducted from sales revenue.
- Net income is calculated as sales minus the cost of goods sold, depreciation, interest, taxes, amortization, and other expenses for a given accounting period.
- It can also be referred to as the net growth in shareholders' equity due to a company's operations.
- It can be manipulated by using techniques like expenditure concealment.
- After-tax is considered the company's bottom line, as found at the bottom of the income statement.
- It accounts for the difference between taxable income and income tax.
- It can also be calculated by deducting operating expenses, other expenses, taxes, and interest on the debt from the gross profit.
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