Net Income

Net Income is a key line item, not only in the income statement, but in all three core financial statements. Net income flows through the balanced sheet through retained earnings, and through the cash flow in the indirect method.

Net Income

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.

The net income is the amount of money 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 and taxes.

Ties to other financial statement

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

In the cash flow statement, net income is used to find operating cash flows in the indirect method. Here, the cash flow statement starts with net income 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 income is also used to determine the net profit margin. This is a handy measure of how profitable the company is, when compared against its past self or other companies.

Net profit margin is also used in the DuPont method for decomposing 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.