Net profit, retained earnings, net pay, the bottom line… you’ve undoubtedly heard these terms thrown around before. But did you know that they’re all synonyms for net income? So let’s figure out what net income is and the role it plays in your company’s accounting.
In our What is an Accounting Transaction? post, we looked at a simple definition of income as an event that results in money flowing into your business. We also covered the profit = income – expenses equation. Everyone loves profits, and net income is crucial when it comes to measuring how profitable your business is during a given period of time.
Just like the profit equation above, there’s also a simple equation for finding net income: net income = total revenue – total expenses. Essentially, you’re taking your company’s total earnings over the course of a given period (your total revenue), and deducting the cost of doing business (your expenses) and taxes. (Want to find out more about expenses? Of course you do. Check out What is an Expense in Accounting?)
The Bottom Line
Net income sometimes referred to as “the bottom line.” Why, you ask? The answer, as it turns, out is pretty simple: it’s because net income is found at the bottom of your income statement, on the very last line. (This is probably the most obvious moment in all of accounting.) It makes sense, then, that actions that increase your business’ earnings (i.e., make your company more profitable) are good for the bottom line!
Revenues are called “top-line” figures, as they’re listed first on the income statement, at the top of the page. Next, expenses (such as rent, cost of goods sold, utilities, and interest) are subtracted from these top-line amounts, which gives you your earnings before tax. Finally, taxes are deducted from this amount. And now you have your net income, your bottom line.
How can you improve your company’s bottom line? There’s no universally magic answer, but these are the two main themes…
- Grow Your Revenues. This is also known as increasing “top-line” growth.
- Reduce Your Expenses. Translation: cut costs. An even more politically correct translation: “increase efficiency.”
Why It Matters
Based on what we’ve seen so far, it should be clear that net income is a pretty important figure. All those entries and calculations are put into your income statement to arrive at this one number at the very bottom of the page. There’s a good reason for that: net income is followed very closely by shareholders, as it’s one of the main indicators of your business’ profitability. When profits are low, the value of your shares will plummet. On the other hand, when your business is healthy and growing strong, stock prices will go up, meaning more profits are available to shareholders.
But even if you’re not incorporated and don’t have shareholders, tracking your net income, net income is still a crucial indicator of your company’s financial progress. It’s used in profitability ratio analysis to determine your profit margin. Suffice it to say, if you’re interested in growing your business (and if you’re reading this, you probably are!), it’s important to have a good handle on concepts like net income so that you can accurately assess your company’s financial health and plan for the future.
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