Net income (net profit) is a financial indicator of the company that shows the real profitability of the business in accordance to its capital structure. Net income is equal to all revenue and gains less all expenses (including taxes) and losses. Net income is also called as earnings or net earnings. Net income is just one type of income while there might be also many others, for example, gross income, operating income.
Despite the fact that there are more types of income, the net income indicator is the most complete and historically used the most often to measure results of the company. But net income is complete and correct indicator only if accounting standards between compared companies are the same and if depreciation of the company has fair effect to the results; one-off income and expenses also should not distort the result of net income. If those conditions are failed then EBIT or EBITDA could better indicator than net income.
Still net income is a very good and informative ratio, but only in good hands. The best way to use net income is to be sure that this indicator is sustainable and trustworthy. Net profit can be used for many purposes but there are few main applicable areas of net income:
• Comparison of profitability to other companies. Every manager of the company or investor should know whether the net income of the company is sufficient, is expected to increase or decrease. To compare net income the best way is to calculate profit margin and compare it to similar companies in the same niche.
• Analysis of changes in profitability. The easiest way to track net income is to compare it to previous period net income of the same company. If business is seasonal then net income should be compared only to the net income of the same period of previous years (for example, third quarter of this year should be compared to the net income of previous year third quarter.
• Stock valuation. Net income is a key part of P/E ratio which is the most popular valuation multiple used for stock valuation. The higher net income the lower is the P/E ratio and the more attractive is stock for investment.
Net income is disclosed in company’s income statement (one of the financial statements) and is at the bottom of the financial statement and because of it also may be called a ‘bottom line’.
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