The primary objective of any business is to be profitable. While there are many ways profitability is analyzed, net income remains a definitive indicator of how a business is doing.

In this FAQ we will discuss what net income is, why it is important, how to interpret it, and the basic function for calculating net income.

What Is Net Income?

Net income is an accounting concept that is a representation of all a business’s earnings less all expenses. It is sometimes referred to as the “bottom-line”. Because net income is an accounting concept, calculation can be impacted by changes in accounting policy.

Why Is Net Income Important?

Net income is a universal concept, meaning it applies both for a big business or an individual. Typically, analysts review net income to understand if the business is a valid going concern . 
Going concern “is an accounting term for a company that is financially stable enough to meet its obligations and continue its business for the foreseeable future.”

Net income over time is monitored to identify if the business is becoming more efficient and growing its revenue base.

In addition, public companies use net income to calculate earnings per share and investors use it to identify expenses.

Interpreting Net Income

One of the limitations of net income is that it includes non-cash expenses like depreciation –  allocating the cost of a tangible asset over its useful life and is used to account for declines in value over time. In addition, it includes amortization – used to periodically lower the book value of a loan or intangible asset over time.

Net income also includes all tax expenses for a period. This can be somewhat convoluted as businesses attempt to reduce net income as much as possible to avoid tax exposure.

In addition, a more relevant metric is EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization). By relying on EBITDA in conjunction with Net Income, analysts can identify how well the business is at pumping out profit in its core business. EBITDA focuses on bare bones information, removing data that can make it harder to understand how profit is related to the core business. Essentially, it removes the noise [JM2] associated with accounting policies, tax exposure, and interest related to current financing agreements.

How To Calculate Net Income

Net income is calculated on the Income Statement. Individuals can calculate net income simply, by taking their net take-home pay and reducing it by their expenses. Businesses rely on a more complex calculation.

The calculation for computing net income can be best summarized using the standard approach to building an income statement. Detailed buckets help guide us through the calculation. An example is below:

Revenue

Total Revenue                                    $xx

Less: COGS                                       $xx

            Gross Profit                             $xx

Less: Operating Expenses                 $xx

            EBITDA                                   $xx

Less: Depreciation Expense               $xx

Less: Amortization Expense               $xx

            EBIT                                        $xx

Less: Interest Expense                       $xx

            EBT                                         $xx

Less: Tax Expense                             $xx

            Net Income                              $xx

It is important to note that you can calculate EBIT or EBITDA using Net Income as a starting point. In this scenario, you would take net income and add back depreciation, amortization, interest, and tax expenses.

Calculating net income on a cash basis is typically more straightforward. The process accounts for all cash receipts as revenue and all cash expenses as operating expenses. Amortization and depreciation are ignored entirely as they are non-cash expenses.

Using Datarails, a Budgeting and Forecasting Solution

Datarails’ FP&A software replaces spreadsheets with real-time data and integrates fragmented workbooks and data sources into one centralized location. This allows users to work in the comfort of Microsoft Excel with the support of a much more sophisticated data management system at their disposal.

Every FP&A analyst in any finance department knows how tedious building a budget and forecast can be. Integrating cash flow forecasts with real-time data and up-to-date budgets is a powerful tool that makes forecasting cash easier, more efficient, and shifts the focus to cash analytics.

Regardless of the budgeting approach your organization adopts, it requires big data to ensure accuracy, timely execution, and of course, monitoring.

Datarails is an enhanced data management tool that can help your team create and monitor cash flow against budgets faster and more accurately than ever before.