Definition
Net income, or net profit, is the amount left from revenue after deducting every expense of the period: cost of sales, operating expenses, finance costs and income tax. It is the bottom line of the income statement, the basis for earnings per share and dividends, and it is added to retained earnings when the year is closed.
How it works
Net income measures profitability on the accrual basis, not cash. A growing business can report strong net income while its bank balance falls, because profit is tied up in receivables and inventory; the cash flow statement reconciles the two using the indirect method.
Dividing net income by revenue gives the net profit margin, and by average equity gives return on equity. These and other ratios are explained in the financial ratio calculator. At year end the closing entry transfers net income through the income summary to retained earnings.
Formula
Net income = Revenue - Cost of sales - Operating expenses - Finance costs - Income tax
Net profit margin % = Net income / Revenue × 100
Example: from revenue to net income
A consulting firm reports the figures below. Net income is 54,000, a net profit margin of 13.5%.
| Line | Amount |
|---|---|
| Revenue | 400,000 |
| Cost of services | (220,000) |
| Gross profit | 180,000 |
| Operating expenses | (105,000) |
| Finance costs | (7,000) |
| Profit before tax | 68,000 |
| Income tax | (14,000) |
| Net income | 54,000 |