Corporate Finance: Understanding Net Income

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Net income of a company over a given period (eg, one year) is equal to the difference between products and expenses (operating) incurred during the same period, including corporate tax.

It is calculated by deducting from the profit before tax (difference between operating income and financial income), all expenses not yet included in the determination of intermediate balances.

The net result is shared between the shareholders (dividend payment), reserves and other provisions. The net result may therefore take the form of a loss (net loss) or profit (net profit).

The net result has been a key indicator for measuring the performance of a company for a number of years. But it no longer plays a role in measuring the performance of a company because it includes all expenses incurred by the company – and hence, it is not a reliable indicator.

To illustrate this point, it is necessary to consider a company that loses a lot of money in some of its core activities. And yet the same company makes a net profit during the year in other trading areas for an amount that compensates for its operating losses.

To overcome this problem, the recurring net income excludes the net special items (those not included in the accounts each year). The central problem of the period of income is the attribution of positive (income or revenue) and negative (expenses or costs) components of the success of the respective observation period.

To this end are economic success components that actually relate to several periods, thus making each period attributable to periodization.

Since the investment appraisal considers the entire (multi-period) economic life of an object, this is not a periodization problem, but of attribution of success factors on a given investment property

The different systems of an income statement is of particular importance, as companies have to be accountable with the outcome of their business activities to third parties (government, investors and other stakeholders).

Relatively unproblematic is the periodization where a large number of individual activities contribute to the periodic success, and the temporal extent of a single business process in relation to a short reference period (short-cycle varieties).

But where a longer term project and service delivery is prevalent – for example in the plant – the attribution of income and expenses for each period is often difficult.

Net is used to calculate, among others things:

    – Cash flow from operations (CFO) of the company;
    – Earnings per share (EPS) of offered shares in the company (where it is traded on financial markets) and, the ratio (PER courses divided by EPS accordingly).

    – The dividend. Companies sometimes choose a distribution policy which is the percentage of earnings (net income) to be distributed as a dividend to shareholders of the company. To have a more critical opinion on the health of a company, the intermediate balances should be investigated more precisely.
 

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