Measuring the financial condition of a company comes in a variety of ways. Net income is the final item on the income statement. Additionally, the net income formula produces that number and shows each line item.
What Is The Net Income Formula?
First of all, net income is a businesses earnings after subtracting expenses such as selling expenses, cost of producing goods, and non-cash items such as depreciation. Most simply, this equation is Net Income = Total Revenues – Total Expenses.
Furthermore, let’s take a look at expense items. The first expense is the cost of goods sold (COGS). Subtracting Revenues from COGS yields gross profit. This shows how much it costs a company to produce sales. Next comes operating expenses. These expenses do not directly relate to production of goods. These include salaries, utilities, and depreciation.
Finally, interest expense and taxes conclude the net income formula. After deducting all the aforementioned expenses, a company finds their net income.
Analyzing The Net Income Formula
As previously mentioned, net income is one of many ways that investors or analysts measure a company’s health. This formula is the root of many ratios in financial analysis. For example, net income shows how well the company returns capital to shareholders through dividends or share repurchases.
Also, net income is not the amount of cash produced by the firm in a given time. How can this be? Non-cash expenses such as depreciation contribute to the net income formula.
This point shows that some consider net income “manipulated”, as companies sometimes take large one-time losses or gains, or choose aggressive depreciation methods. All of these techniques skew net income. Nonetheless, this measure is company specific and provides invaluable information to shareholders and analysts.
In conclusion, accountants use the net income formula as a uniform measure of company profits. The formula is uniform across businesses. This allows ease of analysis for all interested parties.