What is Net Income?

Net income is one of the most important financial indicators for stock investors. It represents the final profit remaining after deducting expenses and taxes from the revenue a company earns over a certain period. Simply put, it is an indicator of how much money a company has earned in a year.

The reason it is important is that net income plays a key role in assessing a company's performance. A higher net income indicates that the company is being operated efficiently and is generating significant profits. Conversely, a lower net income indicates that the company is facing difficulties or that expenses are exceeding revenues.

It is crucial to consider net income when making investment decisions because companies with high net income are more likely to grow and prosper in the future. However, this alone is not enough. It is necessary to analyze it along with other financial indicators and consider the company's prospects and competitiveness.

How to Calculate Net Income

Net income is calculated by subtracting cost of goods sold, selling and administrative expenses, non-operating income and expenses, and corporate taxes from revenue. Here are explanations for each item:

• Revenue: It refers to the income earned by a company from selling goods or services.
• Cost of Goods Sold: It refers to the expenses incurred in producing or purchasing goods or services. In the manufacturing industry, it includes materials cost, labor cost, and manufacturing overhead.
• Selling and Administrative Expenses: It refers to the expenses incurred in selling goods or services or operating a business. It includes salaries, advertising costs, rent, depreciation, etc.
• Non-operating Income: It refers to income generated from activities other than operating activities. It includes interest income, dividend income, rental income, etc.
• Non-operating Expenses: It refers to expenses incurred from activities other than operating activities. It includes interest expenses, foreign exchange losses, donations, etc.
• Corporate Taxes: It refers to taxes levied on the profits earned by a company.

For example, if company A has revenue of KRW 100 million, cost of goods sold of KRW 50 million, selling and administrative expenses of KRW 20 million, non-operating income of KRW 10 million, non-operating expenses of KRW 30 million, and corporate taxes of KRW 10 million, its net income would be KRW 100 million - KRW 50 million - KRW 20 million + KRW 10 million - KRW 30 million - KRW 10 million = KRW 20 million.

In financial statements, net income is displayed at the bottom of the statement of comprehensive income and is expressed in units such as Korean Won or millions of Korean Won.

Analysis of Net Income Fluctuations

Net income is one of the most representative indicators of a company's performance and is very important information for stock investors. Therefore, analyzing the reasons for changes in net income is a process that must be undertaken before investing in stocks.

The most basic reason ischanges in revenue. If a company's revenue has increased, it means that the company's products or services are gaining popularity in the market, which can be considered a positive sign. Conversely, if revenue has decreased, it means that the company's products or services are losing their competitiveness in the market, which is a negative sign.

Next ischanges in expenses. Generally, if expenses increase, net income decreases, and if expenses decrease, net income increases. However, in some cases, an increase in expenses can actually help a company grow. For example, an increase in research and development expenses can be viewed as an investment in future growth.

In addition to the above,exchange rate fluctuations, interest rate fluctuations, political issues, etc.can also affect net income, so it is important to be careful. These external factors are difficult to predict, so before investing in stocks, you should consider both internal and external factors of the company.

Correlation with Other Financial Indicators

As net income is one of the key indicators of a company's performance, it is closely related to other financial indicators.

Among them, the most important isReturn on Equity (ROE). ROE is calculated by dividing net income by equity, showing how efficiently a company is utilizing its equity.

For example, if a company's net income is KRW 100 billion and its equity is KRW 1,000 billion, its ROE is 10%. This means that the company generated KRW 10 billion in profit by investing KRW 100 billion in equity, indicating that the company's management efficiency is high.

Debt Ratiois also closely related to net income. Debt ratio is calculated by dividing a company's total debt by its equity, and is an important indicator for evaluating a company's financial stability.

If a company's debt ratio is high, it means that the company is having difficulty raising funds or that it is incurring high financial costs such as interest expenses, which can lead to a decrease in net income. In the opposite case, a high net income can be expected.

Company Valuation Using Net Income

Net income is a major indicator of a company's performance and is very important information for stock investors. It can be used to determine whether the company's stock price is appropriate. Here are some useful criteria:

• Comparison with PER (Price-to-Earnings Ratio). PER is calculated by dividing the current stock price by earnings per share (EPS), which indicates how many times a company's stock price is its earnings per share. If company A has a PER of 10x and company B has a PER of 5x, it means that company B's stock price is relatively cheaper. If the net income of the two companies is similar, it may be more advantageous to invest in company B.
• Comparison with PBR (Price-to-Book Ratio). PBR is calculated by dividing market capitalization by net assets, which is an indicator that can determine whether a company's stock price is overvalued or undervalued compared to its net asset value. In other words, if PBR is less than 1, it means that the stock price is so low that it is even lower than the book value of net assets (liquidation value). If it is 0.5 or less, it is considered a good stock to consider buying.
• EV/EBITDA (Enterprise Value/Earnings Before Interest, Taxes, Depreciation, and Amortization) Ratiois also related. This is calculated by dividing a company's market value (EV) by its earnings before interest and taxes (EBITDA), which indicates how much cash flow a company can generate using its equity and debt, and may vary from country to country and company to company, so it is best to compare companies in the same industry. Generally, if this ratio is low, it can be seen that the company's market value is undervalued compared to the cash flow generated from operating activities, suggesting high potential for future stock price increases.

Limitations and Precautions of Net Income

As mentioned above, net income is one of the important indicators of a company's performance, but it has several limitations and precautions.

First,net income can vary depending on accounting methods . For example, net income can fluctuate depending on the timing of recognizing expenses or the method of evaluating inventory. For this reason, net income can vary between companies in the same industry.

Next,there are limitations in predicting future profitability. As net income is an indicator of past performance, it lacks predictive power regarding future economic fluctuations or the emergence of competitors. Therefore, it can be risky to make investment decisions based solely on net income.

Finally,it can be distorted by temporary factors. For example, if a company implements a large-scale restructuring or sells assets, net income may temporarily increase, but this is unrelated to the company's actual performance. Similarly, net income can fluctuate significantly due to unexpected events such as exchange rate fluctuations or natural disasters.

Therefore, stock investors should consider a variety of financial indicators, including net income, and analyze the company's business prospects and management strategies together to make investment decisions.

Conclusion

Today, we have taken a closer look at net income, one of the basic financial terms that you must know when investing in stocks.