What is net income?
What is left from revenue after every expense, including interest and taxes, is subtracted. It is the bottom line of the Income Statement.
Definition
Net income is the leftover after the shop subtracts product cost, running costs, interest, taxes, and every other expense from sales. On the books, this is the bottom line of the Income Statement, not a cash balance and not an account you debit day to day.
A bike shop reads it as what remains after bikes and parts that sold, after rent and wages, and after interest and tax. That leftover is the period's profit, not the register total.
It is not a ledger account with a running balance. The statement computes it each period, then the close moves it into retained earnings.
Accrual books use earned sales and incurred costs, even if cash has not moved. A cash-basis reading can shift the same leftover into a different month.
Where it shows up
P&L: Located at the bottom of the Income Statement.
Balance Sheet: Related to retained earnings.
Cash flow: Related to cash from operations, which often starts from this number.
See also: Income Statement · Retained Earnings · Net Margin
When you look at your Income Statement, this leftover sits at the bottom. Revenue sits at the top; product cost, running costs, interest, and tax all come out on the way down.
When the figure is high, the shop kept more of each sales dollar after every cost. When it is low, product cost rose, overhead rose, interest or tax rose, or sales were light.
The Balance Sheet does not print this leftover as its own line. After the close, the same dollars sit in retained earnings, which is equity.
On the Statement of Cash Flows, cash from operations often starts from this leftover and then adjusts for items that were not cash. The two figures are related; they are not the same number.
Operating income is leftover from core work before interest and tax. This bottom line is that leftover after those lower items as well.
How it works
The statement starts with sales. It subtracts the bikes and parts that sold, which leaves gross profit.
It then subtracts the period's operating expenses. Rent, shop wages, utilities, and similar keep-the-doors-open costs come out here.
- Start with sales and subtract cost of goods sold for gross profit.
- Subtract operating expenses to reach operating income.
- Subtract interest, taxes, and other non-operating items.
- What remains is net income—the period's bottom line.
What remains so far is operating income. Interest and taxes have not been subtracted yet.
Interest on a shop loan and the tax charge for the period come out next. Other items that are not core work, such as a gain on selling an old bike stand, also sit in this lower block.
What remains after every subtraction is this leftover. That is the bottom line for the period.
Stay with the full leftover when you read the line. A strong operating leftover can still become a small bottom line if interest or tax is heavy.
Do not treat a strong cash week as this figure. Cash can rise from collecting last month's invoices while this leftover is small.
Cost of goods sold is the bikes that left with customers. That subtraction happens well above this leftover, not as the last step.
After the month closes, this leftover moves into retained earnings. Next month starts the count again from zero.
If the owner takes cash out, that withdrawal is not an expense on the way to this leftover. It comes out of equity after the profit is already counted.
Example
Ridge Line Cycles posts $40,000 of bike and parts sales this month. The bikes that sold cost $22,000, so gross profit is $18,000.
Shop rent, wages, and utilities add up to $12,000 of operating expenses. Subtract those, and operating income is $6,000.
Interest on the shop loan is $800, and the tax charge is $1,000. Subtract those, and net income is $4,200.
The $4,200 lands in retained earnings after the period closes. It is not $4,200 sitting in the till.
If the same month had $1,000 more in wages, this leftover would be $3,200. Sales and product cost would not have to change for the bottom line to move.
Last June the shop posted $36,000 of sales and $3,800 of this leftover. This June's $4,200 is higher in dollars; the rate against sales is a separate reading.
Common mix-ups
Net income is not the same as operating income. Operating income is leftover from core work before interest and taxes; this leftover is after those items as well.
Net income is not the same as cash. A month can show a healthy bottom line while the bank account is waiting on collections.
Net income is not the same as retained earnings. This leftover is one period's profit; retained earnings is the pile of profits kept over time.
Related terms
- Income Statement: A statement showing revenue earned and expenses incurred over a period, ending in net income.
- Operating Income: Profit from core operations before interest and taxes.
- Income Tax Expense: The tax charge recorded against the period's profit.
- Retained Earnings: Cumulative profits kept in the business rather than paid out.
- Net Margin: Net income as a percentage of revenue.
- Cash Flow From Operations: Cash generated or used by the day-to-day running of the business.
- Return On Equity: Net income measured against owner equity.
- Closing Entries: The year-end entries that clear income and expense accounts into retained earnings.