What is the amount of money remaining from a firms sales revenue after it deducts production costs interest costs and taxes?

NI flows through the balanced sheet through retained earnings, and through the cash flow in the indirect method.

Table of Contents Show

• Other Names for Net Income
• Download the Free Template
• Ties to Other Financial Statements
• Profitability and Return on Equity
• Net Income vs. Cash Flow
• Additional Resources

Net income is the amount of accounting profit a company has left over after paying off all its expenses. Net income is found by taking sales revenue and subtracting COGS, SG&A, depreciation, and amortization, interest expense, taxes and any other expenses.

Net income is the last line item on the income statement proper. Some income statements, however, will have a separate section at the bottom reconciling beginning retained earnings with ending retained earnings, through net income and dividends.

Source: Amazon SEC filing

Other Names for Net Income

The bottom line of a company’s income statement has three commonly used names, which include:

• Net Income
• Net Profit
• Net Earnings

All three of these terms mean the same thing, which can sometimes be confusing for people who are new to finance and accounting.

In this article, we use all three terms interchangeably.

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Ties to Other Financial Statements

The net income is very important in that it is a central line item to all three financial statements. While it is arrived at through the income statement, the net profit is also used in both the balance sheet and the cash flow statement.

Net income flows into the balance sheet through retained earnings, an equity account. This is the formula for finding ending retained earnings:

Ending RE = Beginning RE + Net Income – Dividends

Assuming there are no dividends, the change in retained earnings between periods should equal the net earnings in those periods. If there is no mention of dividends in the financial statements, but the change in retained earnings does not equal net profit, then it’s safe to assume that the difference was paid out in dividends.

In the cash flow statement, net earnings are used to calculate operating cash flows using the indirect method. Here, the cash flow statement starts with net earnings and adds back any non-cash expenses that were deducted in the income statement. From there, the change in net working capital is added to find cash flow from operations.

Profitability and Return on Equity

Net earnings are also used to determine the net profit margin. This is a handy measure of how profitable the company is on a percentage basis, when compared to its past self or to other companies.

Net profit margin is also used in the DuPont method for decomposing return on equity – ROE. The basic DuPont formula splits ROE out into three components:

ROE = Net Profit Margin x Total Asset Turnover x Financial Leverage

Analyzing a company’s ROE through this method allows the analyst to determine the company’s operational strategy. A company with high ROE due to high net profit margins, for example, can be said to operate a product differentiation strategy.

Net Income vs. Cash Flow

Net income is an accounting metric and does not represent the economic profit or cash flow of a business.

Since net profit includes a variety of non-cash expenses such as depreciation, amortization, stock-based compensation, etc., it is not equal to the amount of cash flow a company produced during the period.

For this reason, financial analysts go to great lengths to undo all of the accounting principles and arrive at cash flow for valuing a company.

To learn more, explore CFI’s financial modeling courses.

Additional Resources

Thank you for reading CFI’s guide to Net Income. The CFI resources below are designed to give you the tools and training you need to become a great financial analyst:

• Free Reading Financial Statements Course

The terms "profit" and "income" are often used interchangeably in day-to-day life. In corporate finance, however, these terms can have very different and specific meanings, depending on the context in which they are used.

While income does mean positive flow of cash into a business, net income is something much more complex. Profit is generally understood to refer to the cash that is left over after accounting for expenses. Though both gross profit and operating profit fit this definition in the simplest sense, the kinds of income and expenses that are accounted for differ in important ways.

• Gross profit is the total revenue minus the expenses directly related to the production of goods for sale, called the cost of goods sold.
• Derived from gross profit, operating profit reflects the residual income that remains after accounting for all the costs of doing business.
• Net income reflects the total residual income that remains after accounting for all cash flows, both positive and negative.

Gross profit, operating profit, and net income are all types of earnings that a company generates. However, each metric represents profit at different parts of the production cycle and earnings process. All three financial metrics are located on a company's income statement and the order in which they appear help show the relationship to each other and their importance.

The top line of the income statement reflects a company's gross revenue or the total amount of income generated by the sale of goods or services. From there, various expenses and alternate income streams are added and subtracted to arrive at the various levels of profit.

Gross profit is the total revenue less only those expenses directly related to the production of goods for sale, called the cost of goods sold (COGS). COGS represents direct labor, direct materials or raw materials, and a portion of manufacturing overhead that's tied to the production facility.

COGS does not include indirect expenses, such as the cost of the corporate office. COGS is a key metric since it directly impacts a company's gross profit, which is calculated as follows:

Image by Sabrina Jiang © Investopedia 2021

Since COGS represents the cost of acquiring inventory and manufacturing the products, gross profit reflects the revenue left over to fund the business after accounting for the costs of production.

While gross profit is technically a net measurement of profit, it is referred to as gross because it does not include debt expenses, taxes, or all of the other expenses involved in running the company.

Next on the income statement is operating profit. Derived from gross profit, operating profit reflects the residual income that remains after accounting for all the costs of doing business. In addition to COGS, this includes fixed-cost expenses such as rent and insurance, variable expenses, such as shipping and freight, payroll and utilities, as well as amortization and depreciation of assets. All the expenses that are necessary to keep the business running must be included.

Image by Sabrina Jiang © Investopedia 2021

However, like gross profit, operating profit does not account for the cost of interest payments on debts, tax expense, or additional income from investments. Operating profit reflects the profitability of a company's operations.

Operating profit is also referred to as earnings before interest and tax (EBIT). However, EBIT can include non-operating revenue, which is not included in operating profit. If a company doesn't have non-operating revenue, EBIT and operating profit will be the same figure.

A company's profit is called net income or net profit. Since net income is the last line located at the bottom of the income statement, it's also referred to as the bottom line.

Net income reflects the total residual income that remains after accounting for all cash flows, both positive and negative. In other words, from revenue, which is called the top-line number, all income, expenses, and costs are deducted to arrive at net income.

From the operating profit figure, debt expenses such as loan interest, taxes, and one-time entries for unusual expenses such as lawsuits or equipment purchases are all subtracted. All additional income from secondary operations or investments and one-time payments for things such as the sale of assets are added.

Net income is arguably the most important financial metric, reflecting a company's ability to generate profit for owners and shareholders alike.

Below is a sample income statement to illustrate the differences and locations of the three profitability metrics.

Gross profit (labeled as gross income) was $3 million for the quarter (or revenue of $5 million minus $2 million in COGS).

Operating profit was $2.2 million for the period, which is calculated by taking gross profit of $3 million minus operating expenses of $1 million (labeled total expenses). However, we must add back in the interest expense of $200,000 because operating profit doesn't include interest (or $3 million - $1 million + $200,000 = $2.2 million).

Net income was $1.5 million for the period, which is located at the bottom of the income statement.