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Net Profit is a measure of profitability of the company after taking into consideration all costs incurred during an accounting period. Net profit is also referred to as net income, net earnings, bottom line, profit after tax (commonly known as PAT) etc.
Meaning of Net Profit
In simple words, it is the money left over after paying off all expenses including cost of goods sold, selling and administrative expenses, operating and non-operating expenses, depreciation, interest payments, preference dividend (if any) and taxes. Net income is reported on the income statement (profit and loss account) and forms a key indicator of a company’s performance. Financial analysts find out net profit margin for their analysis and comparison purposes.
Net profit or earnings are different from Earnings before Interest and Tax (EBIT; aka Operating Income / Operating Profit) and Earnings before Interest Tax Depreciation and Amortisation (EBIDTA). Let us look at an example of the income statement to get a clear understanding of the various elements of an income statement. Before the example, let us briefly understand what an income statement or profit and loss account are?
What is an Income Statement?
An income statement is the summary of a company’s financial performance over a specific period of time. It is one of the three important financial statements used to analyze a company’s performance. The other two are the balance sheet and the cash flow statements. An income statement is also called a profit and loss statement, statement of income or statement of operations.
Components of an Income Statement
An Income Statement comprises 3 parts which are:
- Revenue or Income
- Profit (or loss) i.e. (Revenue – Expenses)
An income statement itemizes every source of revenue and expense that the company has made over the period under consideration. The difference between the income earned and the expense made gives the amount with which the owner’s equity is changing. A positive difference will indicate a rise in the owner’s equity by the corresponding amount and a negative difference will indicate a drop in the owner’s equity.
Example of Income Statement
|Income Statement||Amount in Mio|
|Sales revenue||$ 600|
|Less: Cost of goods sold||$ 275|
|Gross Profit (GP)||$ 325|
|Less: Operating Expenses|
|Other operating expenses||$ 10||$ 70|
|Less: Depreciation||$ 30|
|Less: Amortisation||$ 10|
|EBIT (Operating Income)||$ 215|
|Less: Interest||$ 15|
|Profit Before Tax (PBT)||$ 200|
|Less: Tax (@ 35%)||$ 70|
|Profit After Tax (Net Profit)||$ 130|
To understand net profit closely, let us understand the terms which are used in deriving net profit in an income statement:
Gross profit is the difference between the revenue generated and cost incurred in making the product to be sold or services to be rendered. It is also referred to as sales profit which in our example is $ 600 – $ 275 = $ 325.
Earnings before interest, depreciation, taxes, and amortization is a financial measure to represent the cash flow situation of a company. It is a measure usually used by lenders to ascertain that the company has enough cash flow available to make interest and principal repayments on loans that will be given. It is also used to gauge the short-term liquidity health of the company. A company with a negative EBIDTA may be more worrisome for a lender to give any new credit line too.
‘Earnings before interest and taxes’ (EBIT) is more commonly referred to as operating income or operating profit and is a measure of company’s earning ability. Operating income is the income generated by the company by its day to day operating activities. It signifies how stable revenue of the company is. A company with a stable EBIT or increasing EBIT is considered favorable even if the profits of the company are fluctuating.
PBT and PAT
Profit before taxes is the earnings just before making the tax payments and PAT is the profits booked by the company post payment of tax. PAT is also referred to as the net earnings or net income or net profit or the bottom line. Net profit is the key number which determines the final profitability of the company and there are various financial ratios that are linked to net profit for analyzing the performance or year-on-year growth of a company.
Retained earnings refer to that part of the profit which is invested back into the business. This is the value of net earnings invested back in the business after deducting the amount paid as dividends to the shareholders. If no dividends are paid the retained earnings will be same as net earnings or net profit for the year.
References:February 21st, 2018