At the end of a financial year, companies prepare their balance sheets in order to gain an overview of all income and expenses. The term net profit is often used in this context. In this article, you will find out exactly what net profit means, how it is calculated and how it is used in practice.
Net income Definition
This is a Key business figure. This comes from the profit and loss account and provides an overview of the success of a company within a year.
- The term is defined in Section 275 of the German Commercial Code.
- Specifically, this is the profit of a company, whereby the costs for all expenses have already been deducted. Such expenses are, for example, personnel or material costs. A profit is made if the income for the year exceeds the costs incurred for expenses in the same year.
- If, instead, the costs for the expenses are higher than the income, this is referred to as a net loss for the year.
The net profit for the year acts as a balance sheet item and must be identical to the balance of the income statement be. In the balance sheet itself, it is recognized as part of the Equity are reported. In accordance with German commercial law, the surplus is the last item in the income statement.
Difference between net income and retained earnings
The meanings of net income and retained earnings differ. It is only a retained profit if the surplus has been adjusted. In doing so Profit or loss carryforwards, potential reserves or capital withdrawals be taken into account.
This can result in a balance sheet loss due to high losses carried forward, even though there is a surplus. In principle, a positive amount represents a balance sheet profit, while a negative amount represents a balance sheet loss.
What is the difference between net income and profit?
This key figure is the net profit, after the taxes have been deducted. The terms "surplus" and "turnover" should therefore not be confused with each other.
Der Begriff Profit is not always clearly defined, which is why the Meaning from the context results. The meanings of surplus and deficit, on the other hand, are firmly defined.
Calculate net income for the year: Simply explained
The key figure is calculated by all expenses of the financial year summed up are recognized. The expenses are then deducted from the income for the financial year. If this calculation produces a positive result, this is the surplus. If the final total is negative, the net loss for the year is calculated.
- Accordingly, the calculation of the surplus takes into account the result from ordinary activities, taxes and extraordinary income as well as expenses.
- If the retained earnings are then to be calculated, other factors such as reserves or losses carried forward are taken into account in the calculation and deducted from the original figure.
How do companies use their net income?
Let's assume that a company has a net profit at the end of a financial year: The company now has three options regarding the use of the surplus:
Allowing shareholders to participate
If the company is a public limited company, it is an option to distribute a portion to the shareholders. This takes the form of a Dividend. However, this can only work if there is a balance sheet profit.
Profit carried forward for next year
Another option is to use the surplus for the next financial year. If the annual surplus is added to the balance sheet, a balance sheet profit can be calculated, which can make it possible to pay out dividends in a loss-making year.
Accumulation
Retaining profits makes it possible to actively use the profits. For example, the company can decide to make investments or increase its own reserves for economically challenging times. In public limited companies, profits can be retained without the consent of the Annual General Meeting up to 50 percent as retained earnings.
Net income as a key figure - who can benefit?
Key figures such as the surplus can provide useful information for investors:
- The surplus helps them to understand whether companies are profitable after deducting all costs.
- Some other variations of the profit may give an unrealistic impression, as important costs have often not been deducted.
- In combination with other economic indicators, the surplus can help investors to better assess companies of interest and, if necessary, adjust their own investment strategy.
In addition to investors, the companies themselves also benefit from the calculation of the surplus. The key figure can help them to Analyze your own corporate strategy and assess it. Companies often use the surplus to assess their own success, as all taxes and costs have to be deducted in advance.
In principle, it should be mentioned that it is not sufficient to look at a single key figure. Both investors and companies see net income, in combination with other indicators such as the Profit growth, This is useful information for adapting your own strategies.
Net income and its restrictions
Even if the ratio can be useful, there are limitations. For example, it makes less sense to compare two companies on the basis of their surplus. Even if the same industry is selected, different locations can lead to various tax laws or other regulations occur. These can have an impact on the key figure, which makes objective comparisons difficult.
Another limitation lies in the Design options for companies. These are normally aimed at achieving a positive net profit for the year and thus being able to present a positive financial year. However, the surplus can be changed in a targeted manner. For example, there is the option of creating provisions. This often results in a comparatively simple reversal or formation.
Conclusion: What does net income mean?
In summary, the term is a business ratio that is defined in Section 275 of the German Commercial Code. It refers to the Profit of a company, less taxes and all expenses incurred of the same year. If the costs are higher than the income, there is a net loss for the year.
The Calculation is comparatively simple: in order to obtain the surplus, the expenses must be deducted from the income. If the Retained earnings In addition, reserves, capital withdrawals and potential profit or loss carryforwards must also be taken into account.
Companies can use the surplus to carry forward profits. Alternative options are the payout of Dividends to shareholders or active utilization, for example in the form of Accumulation of reserves or Investments.
Investors can use this key figure to get a better picture of a company. The key figure is also important for the companies themselves and can be used to assess their own strategy.
However, there are Limits of interpretation: Companies can use specific structuring options to influence the key figure. In addition, caution is advised when comparing two companies on the basis of net income. Various framework conditions such as local tax regulations can influence the net profit.