Financial Terms
Net income

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Definition of Net income

Net Income Image 1

Net income

The company's total earnings, reflecting revenues adjusted for costs of doing business,
depreciation, interest, taxes and other expenses.

Net income

The excess of revenues over expenses, including the impact of income taxes.

Net income

The last line of the income Statement; it represents the amount that the company earned during a specified period.


The profit a company makes after cost of goods sold, expenses, and taxes are subtracted from net sales.

Related Terms:

net income (also called the bottom line, earnings, net earnings, and net

operating earnings)
This key figure equals sales revenue for a period
less all expenses for the period; also, any extraordinary gains and losses
for the period are included in this final profit figure. Everything is taken
into account to arrive at net income, which is popularly called the bottom
line. net income is clearly the single most important number in business
financial reports.


A ratio that shows how much net income (profit) a company made on each dollar of net sales. Here’s the formula:
(net income) / (net sales)


A ratio that shows how much a company had to collect in net sales to make a dollar of profit. Figure it this way:
(net sales) / (net income)

Adjusted Earnings

net income adjusted to exclude selected nonrecurring and noncash items of reserve, gain, expense, and loss.

Net Income Image 2

After-tax profit margin

The ratio of net income to net sales.

basic earnings per share (EPS)

This important ratio equals the net
income for a period (usually one year) divided by the number capital
stock shares issued by a business corporation. This ratio is so important
for publicly owned business corporations that it is included in the daily
stock trading tables published by the Wall Street Journal, the New York
Times, and other major newspapers. Despite being a rather straightforward
concept, there are several technical problems in calculating
earnings per share. Actually, two EPS ratios are needed for many businesses—
basic EPS, which uses the actual number of capital shares outstanding,
and diluted EPS, which takes into account additional shares of
stock that may be issued for stock options granted by a business and
other stock shares that a business is obligated to issue in the future.
Also, many businesses report not one but two net income figures—one
before extraordinary gains and losses were recorded in the period and a
second after deducting these nonrecurring gains and losses. Many business
corporations issue more than one class of capital stock, which
makes the calculation of their earnings per share even more complicated.

Before-tax profit margin

The ratio of net income before taxes to net sales.

bottom line

A commonly used term that refers to the net income (profit)
reported by a business, which is the last, or bottom line, in its income
statement. As you undoubtedly know, the term has taken on a much
broader meaning in everyday use, referring to the ultimate or most important
effect or result of something. Not many accounting-based terms have
found their way into everyday language, but this is one that has.

Cash Flow

In investments, net income plus DEPRECIATION and other noncash charges. In this sense, it is synonymous with CASH EARNINGS. Investors focus on cash flow from operations because of their concern with a firm's ability to pay dividends.

Cash flow after interest and taxes

net income plus depreciation.

cash flow from operating activities, or cash flow from profit

This equals the cash inflow from sales during the period minus the cash
outflow for expenses during the period. Keep in mind that to measure
net income, generally accepted accounting principles require the use of
accrual-basis accounting. Starting with the amount of accrual-basis net
income, adjustments are made for changes in accounts receivable,
inventories, prepaid expenses, and operating liabilities—and depreciation
expense is added back (as well as any other noncash outlay
expense)—to arrive at cash flow from profit, which is formally labeled
cash flow from operating activities in the externally reported statement
of cash flows.

Cash flow from operations

A firm's net cash inflow resulting directly from its regular operations
(disregarding extraordinary items such as the sale of fixed assets or transaction costs associated with issuing
securities), calculated as the sum of net income plus non-cash expenses that were deducted in calculating net

Cash Flow Provided by Operating Activities

With some exceptions, the cash effects of transactions
that enter into the determination of net income, such as cash receipts from sales of goods
and services and cash payments to suppliers and employees for acquisitions of inventory and

Net Income Image 3

cost-volume-profit (CVP)

analysis a procedure that examines
changes in costs and volume levels and the resulting
effects on net income (profits)

degree of operating leverage

a factor that indicates how a percentage change in sales, from the existing or current
level, will affect company profits; it is calculated as contribution
margin divided by net income; it is equal to (1 - margin of safety percentage)


Refers to the generally accepted accounting principle of allocating
the cost of a long-term operating asset over the estimated useful
life of the asset. Each year of use is allocated a part of the original cost of
the asset. Generally speaking, either the accelerated method or the
straight-line method of depreciation is used. (There are other methods,
but they are relatively rare.) Useful life estimates are heavily influenced
by the schedules allowed in the federal income tax law. Depreciation is
not a cash outlay in the period in which the expense is recorded—just
the opposite. The cash inflow from sales revenue during the period
includes an amount to reimburse the business for the use of its fixed
assets. In this respect, depreciation is a source of cash. So depreciation is
added back to net income in the statement of cash flows to arrive at cash
flow from operating activities.

Discontinued Operations

net income and the gain or loss on disposal of a business segment whose assets and operations are clearly distinguishable from the other assets and operations of an entity.

dividend payout ratio

Computed by dividing cash dividends for the year
by the net income for the year. It’s simply the percent of net income distributed
as cash dividends for the year.


net income for the company during the period.


Refers to one of the two basic sources of capital for a business, the
other being debt (borrowed money). Most often, it is called owners’
equity because it refers to the capital used by a business that “belongs”
to the ownership interests in the business. Owners’ equity arises from
two quite distinct sources: capital invested by the owners in the business
and profit (net income) earned by the business that is not distributed to
its owners (called retained earnings). Owners’ equity in our highly developed
and sophisticated economic and legal system can be very complex—
involving stock options, financial derivatives of all kinds, different
classes of stock, convertible debt, and so on.

extraordinary gains and losses

No pun intended, but these types of gains
and losses are extraordinarily important to understand. These are nonrecurring,
onetime, unusual, nonoperating gains or losses that are
recorded by a business during the period. The amount of each of these
gains or losses, net of the income tax effect, is reported separately in the
income statement. net income is reported before and after these gains
and losses. These gains and losses should not be recorded very often, but
in fact many businesses record them every other year or so, causing
much consternation to investors. In addition to evaluating the regular
stream of sales and expenses that produce operating profit, investors
also have to factor into their profit performance analysis the perturbations
of these irregular gains and losses reported by a business.

financial reports and statements

Financial means having to do with
money and economic wealth. Statement means a formal presentation.
Financial reports are printed and a copy is sent to each owner and each
major lender of the business. Most public corporations make their financial
reports available on a web site, so all or part of the financial report
can be downloaded by anyone. Businesses prepare three primary financial
statements: the statement of financial condition, or balance sheet;
the statement of cash flows; and the income statement. These three key
financial statements constitute the core of the periodic financial reports
that are distributed outside a business to its shareowners and lenders.
Financial reports also include footnotes to the financial statements and
much other information. Financial statements are prepared according to
generally accepted accounting principles (GAAP), which are the authoritative
rules that govern the measurement of net income and the reporting
of profit-making activities, financial condition, and cash flows.
Internal financial statements, although based on the same profit
accounting methods, report more information to managers for decision
making and control. Sometimes, financial statements are called simply

fractional interest discount

the combined discounts for lack of control and marketability. g the constant growth rate in cash flows or net income used in the ADF, Gordon model, or present value factor.

Income from Continuing Operations

After-tax net income before discontinued operations,
extraordinary items, and the cumulative effect of changes in accounting principle.

Net Income Image 4


An accounting statement that summarizes information about a company in the following format:
net Sales
– Cost of goods sold
Gross profit
– Operating expenses
Earnings before income tax
income tax
= net income or (net loss)
Formally called a “consolidated earnings statement,” it covers a period of time such as a quarter or a year.

income statement

Financial statement that summarizes sales revenue
and expenses for a period and reports one or more profit lines for the
period. It’s one of the three primary financial statements of a business.
The bottom-line profit figure is labeled net income or net earnings by
most businesses. Externally reported income statements disclose less
information than do internal management profit reports—but both are
based on the same profit accounting principles and methods. Keep in
mind that profit is not known until accountants complete the recording
of sales revenue and expenses for the period (as well as determining any
extraordinary gains and losses that should be recorded in the period).
Profit measurement depends on the reliability of a business’s accounting
system and the choices of accounting methods by the business. Caution:
A business may engage in certain manipulations of its accounting methods,
and managers may intervene in the normal course of operations for
the purpose of improving the amount of profit recorded in the period,
which is called earnings management, income smoothing, cooking the
books, and other pejorative terms.

income statement

Financial statement that shows the revenues, expenses, and net income of a firm over a period of time.

Indirect method

A method of preparing the operating section of the Statement of Cash Flows that does not use the company’s actual cash inflows and cash outflows, but instead arrives at the net cash flow by taking net income and adjusting it for noncash expenses and the changes from last year in the current assets and current liabilities.

Net profit margin

net income divided by sales; the amount of each sales dollar left over after all expenses
have been paid.

Normalizing method

The practice of making a charge in the income account equivalent to the tax savings
realized through the use of different depreciation methods for shareholder and income tax purposes, thus
washing out the benefits of the tax savings reported as final net income to shareholders.

operating activities

Includes all the sales and expense activities of a business.
But the term is very broad and inclusive; it is used to embrace all
types of activities engaged in by profit-motivated entities toward the
objective of earning profit. A bank, for instance, earns net income not
from sales revenue but from loaning money on which it receives interest
income. Making loans is the main revenue operating activity of banks.

Operating income

The net income of a business, less the impact of any financial activity,
such as interest expense or investment income, as well as taxes and extraordinary

Pro-Forma Earnings

Reported net income with selected nonrecurring items of revenue or gain
and expense or loss deducted from or added back, respectively, to reported net income. Occasionally
selected nonoperating or noncash items are also treated as adjustment items.


The general term profit is not precisely defined; it may refer to net
gains over a period of time, or cash inflows less cash outflows for an
investment, or earnings before or after certain costs and expenses are
deducted from income or revenue. In the world of business, profit is
measured by the application of generally accepted accounting principles
(GAAP). In the income statement, the final, bottom-line profit is generally
labeled net income and equals revenue (plus any extraordinary gains)
less all expenses (and less any extraordinary losses) for the period. Inter-
nal management profit reports include several profit lines: gross margin,
contribution margin, operating profit (earnings before interest and
income tax), and earnings before income tax. External income statements
report gross margin (also called gross profit) and often report one
or more other profit lines, although practice varies from business to
business in this regard.

Profit margin

Indicator of profitability. The ratio of earnings available to stockholders to net sales.
Determined by dividing net income by revenue for the same 12-month period. Result is shown as a

Profit Margin Ratio

A measure of how much profit is earned on each dollar of sales. It
is calculated by dividing the net income available for distribution to
shareholders by the total sales generated during the period.

profit module

This concept refers to a separate source of revenue and
profit within a business organization, which should be identified for
management analysis and control. A profit module may focus on one
product or a cluster of products. Profit in this context is not the final, bottom-
line net income of the business as a whole. Rather, other measures
of profit are used for management analysis and decision-making purposes—
such as gross margin, contribution margin, or operating profit
(earnings before interest and income tax).

profit ratios

Ratios based on sales revenue for a period. A measure of
profit is divided by sales revenue to compute a profit ratio. For example,
gross margin is divided by sales revenue to compute the gross margin
profit ratio. Dividing bottom-line profit (net income) by sales revenue
gives the profit ratio that is generally called return on sales.

Purchase method

Accounting for an acquisition using market value for the consolidation of the two entities'
net assets on the balance sheet. Generally, depreciation/amortization will increase for this method compared
with pooling and will result in lower net income.


The percentage return or profit that management made on each dollar stockholders invested in a company. Here’s how you figure it:
(net income) / (Stockholders’ equity)


The percentage return or profit that management made on each dollar of assets. The formula is:
(net income) / (Total assets)


Profits a company plowed back into the business over the years. Last January’s retained earnings, plus the net income or profit that a company made this year (which is calculated on the income statement), minus dividends paid out, equals the retained earnings balance on the balance sheet date.

Return on assets (ROA)

Indicator of profitability. Determined by dividing net income for the past 12 months
by total average assets. Result is shown as a percentage. ROA can be decomposed into return on sales (net
income/sales) multiplied by asset utilization (sales/assets).

Return on Common Equity Ratio

A measure of the percentage return earned on the value of the
common equity invested in the company. It is calculated by
dividing the net income available for distribution to shareholders
by the book value of the common equity.

Return on equity (ROE)

Indicator of profitability. Determined by dividing net income for the past 12
months by common stockholder equity (adjusted for stock splits). Result is shown as a percentage. Investors
use ROE as a measure of how a company is using its money. ROE may be decomposed into return on assets
(ROA) multiplied by financial leverage (total assets/total equity).


In its most basic form, the rate of return equals net income divided by the amount of money invested. It can be applied to a particular product or piece of equipment, or to a business as a whole.

return on sales

This ratio equals net income divided by sales revenue.

Return on Total Assets Ratio

A measure of the percentage return earned on the value of the
assets in the company. It is calculated by dividing the net income
available for distribution to shareholders by the book value of all

Statement Retained Earnings

One of the basic financial statements; it takes the beginning balance of retained earnings and adds net income, then subtracts dividends. The Statement of Retained Earnings is prepared for a specified period of time.

Accrued Income

income that has been earned but not yet received. For instance, if you have a non-registered Guaranteed Investment Certificate (GIC), Mutual Fund or Segregated Equity Fund, growth accrues annually or semi-annually and is taxable annually even though the gain is only paid at maturity of your investment.

Accumulated Other Comprehensive Income

Cumulative gains or losses reported in shareholders'
equity that arise from changes in the fair value of available-for-sale securities, from the
effects of changes in foreign-currency exchange rates on consolidated foreign-currency financial
statements, certain gains and losses on financial derivatives, and from adjustments for underfunded
pension plans.

Adjusted Income from Continuing

Operations Reported income from continuing operations
adjusted to remove nonrecurring items.

approximated net realizable value at split-off allocation

a method of allocating joint cost to joint products using a
simulated net realizable value at the split-off point; approximated
value is computed as final sales price minus
incremental separate costs

Book Income

Pretax income reported on the income statement.

Cash Flow–to–Income Ratio (CFI)

Adjusted cash flow provided by continuing operations
divided by adjusted income from continuing operations.

common-size income statement

income statement that presents items as a percentage of revenues.

Current Income Tax Expense

That portion of the total income tax provision that is based on
taxable income.

Deferred Income Tax Expense

That portion of the total income tax provision that is the result
of current-period originations and reversals of temporary differences.

Disposable Income

income less income tax.

Dividend income

income that a company receives in the form of dividends on stock in other companies that it holds.

earned income

Earned income is generally an individual's salary or wages from employment. It also includes some taxable benefits. Earned income also includes business income if the individual is self-employed. Earned income is used as the basis for calculating RRSP maximum contribution limits.

earnings before interest and income tax (EBIT)

A measure of profit that
equals sales revenue for the period minus cost-of-goods-sold expense
and all operating expenses—but before deducting interest and income
tax expenses. It is a measure of the operating profit of a business before
considering the cost of its debt capital and income tax.

Economic income

Cash flow plus change in present value.

Employee Retirement Income Security Act of 1974 (ERISA)

A federal Act that sets minimum operational and funding standards for employee benefit

European Monetary System (EMS)

An exchange arrangement formed in 1979 that involves the currencies
of European Union member countries.

Exposure netting

Offsetting exposures in one currency with exposures in the same or another currency,
where exchange rates are expected to move in such a way that losses or gains on the first exposed position
should be offset by gains or losses on the second currency exposure.

Firm's net value of debt

Total firm value minus total firm debt.

Fixed-income equivalent

Also called a busted convertible, a convertible security that is trading like a straight
security because the optioned common stock is trading low.

Fixed-income instruments

Assets that pay a fixed-dollar amount, such as bonds and preferred stock.

Fixed-income market

The market for trading bonds and preferred stock.

Fixed-income security

A security that pays a specified cash flow over a
specific period. Bonds are typical fixed-income securities.


net earnings after all expenses for an accounting period are subtracted from all
revenues recognized during that period.

Income beneficiary

One who receives income from a trust.

Income bond

A bond on which the payment of interest is contingent on sufficient earnings. These bonds are
commonly used during the reorganization of a failed or failing business.

Income fund

A mutual fund providing for liberal current income from investments.

income funds

Mutual funds that seek regular income. This type of fund invests primarily in government, corporate and other types of bonds, debt securities, and other income producing securities and in certain circumstances can also hold common and preferred shares.

Income Smoothing

A form of earnings management designed to remove peaks and valleys
from a normal earnings series. The practice includes taking steps to reduce and “store” profits
during good years for use during slower years.

Income Splitting

This is a tax planning strategy of arranging for income to be transferred to family members who are in lower tax brackets than the one earning the income, thus reducing taxes. Even though attribution rules limit income splitting, there are still a number of legitimate ways to do so, such as through the use of spousal RRSPs.

Income Statement

One of the basic financial statements; it lists the revenue and expense accounts of the company.
The income Statement is prepared for a given period of time.

Income statement

A financial report that summarizes a company’s revenue, cost of
goods sold, gross margin, other costs, income, and tax obligations.

Income statement (statement of operations)

A statement showing the revenues, expenses, and income (the
difference between revenues and expenses) of a corporation over some period of time.

Income Statements

A financial statement that displays a breakdown of total sales and total expenses.

Income stock

Common stock with a high dividend yield and few profitable investment opportunities.


What the business paid to the IRS.

Income tax

A government tax on the income earned by an individual or corporation.

Income Tax Expense

See income tax provision.

Income Tax Provision

The expense deduction from pretax book income reported on the
income statement. It consists of both current income tax expense and deferred income tax
expense. The terms income tax expense and income tax provision are used interchangeably.

Incomes Policy

A policy designed to lower inflation without reducing aggregate demand. Wage/price controls are an example.

Interest income

income that a company receives in the form of interest, usually as the result of keeping money in interest-bearing accounts at financial institutions and the lending of money to other companies.

International Monetary Fund

An organization founded in 1944 to oversee exchange arrangements of
member countries and to lend foreign currency reserves to members with short-term balance of payment

International Monetary Fund (IMF)

Organization originally established to manage the postwar fixed exchange rate system.

International Monetary Market (IMM)

A division of the CME established in 1972 for trading financial
futures. Related: Chicago Mercantile Exchange (CME).

Internet business model

a model that involves
(1) few physical assets,
(2) little management hierarchy, and
(3) a direct pipeline to customers


a mechanism for sharing information and delivering data from corporate databases to the local-area network (LAN) desktops

Investment income

The revenue from a portfolio of invested assets.
Investment management Also called portfolio management and money management, the process of
managing money.

Life Income Fund

Commonly known as a LIF, this is one of the options available to locked in Registered Pension Plan (RPP) holders for income payout as opposed to Registered Retirement Savings Plan (RRSP) holders choice of payout through Registered Retirement income Funds (RRIF). A LIF must be converted to a unisex annuity by the time the holder reaches age 80.







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