Net Income

From operating profit to net income

Between operating profit and net income, an IFRS income statement typically shows:

• Financial income and expenses: interest on loans, bonds and lease liabilities, interest earned on cash, and exchange rate differences on financial items.
• Share of results of associated companies and joint ventures, when the company presents it below operating profit.
• Income taxes: current tax for the period and the change in deferred taxes. Divided by profit before tax, this gives the effective tax rate.
• Discontinued operations (IFRS 5): the after-tax result of a business the company has sold or decided to sell, shown on a single line so that the rest of the income statement covers only the continuing business.

The result is then split between owners of the parent and non-controlling interests. The worked example above follows these steps with one company’s latest quarter.

How to read net income

• Use net margin to compare. Net income divided by revenue shows how much of each euro of sales ends up as profit; see the net margin calculator.
• Separate the business from financing. If net income falls while operating profit rises, the cause is below the operating line: higher interest costs, a higher tax rate or a loss in discontinued operations.
• Look for one-off items. Impairments, gains on selling a business, tax rulings and restatements all pass through net income. Many companies therefore also report an adjusted EPS.
• Read it per share. Net income attributable to owners divided by the average number of shares gives earnings per share, which is what dividends and valuations such as the P/E ratio are based on.
• Compare with cash flow. Over several years, cash flow from operations should broadly keep up with net income plus depreciation. A persistent gap deserves an explanation.

What net income does not tell you

• It is not cash. Net income includes non-cash items such as depreciation, impairments and fair value changes, and it ignores investment spending and changes in working capital.
• One quarter can mislead. A single large item can turn a profitable quarter into a loss or the other way round. Look at the last twelve months and the trend.
• It does not show the capital used. Two companies with the same net income can have very different amounts of equity behind it; return on equity puts the two together.
• Other comprehensive income is left out. Some gains and losses, such as currency translation differences of foreign subsidiaries and some pension remeasurements, go directly to other comprehensive income and never pass through net income.

Net income is the right starting point for what shareholders earned. To judge how the business itself performed, start from operating profit instead.

Net income, earnings per share and the P/E ratio

Net income becomes the basis of most share valuations through earnings per share. Under IAS 33, basic EPS is net income attributable to owners of the parent divided by the weighted average number of shares outstanding during the period, excluding treasury shares. Diluted EPS also counts shares that could be issued under options, share plans and convertible instruments.

The P/E ratio divides the share price by EPS, usually for the last twelve months or for a forecast year. Because EPS comes from net income, every item that moves net income, including one-off gains and losses, moves the P/E ratio too. That is why analysts often calculate P/E on adjusted EPS as well as on reported EPS; use the P/E ratio calculator to try both.