Net Income

For a long time the answer to "is the company doing well?" was the balance in the bank account. A fat balance meant a healthy business and an empty one meant trouble. But a bank balance grows on borrowed money too, and it looks just as fat holding next month's tax bill and prepayments for undelivered service.

So investors and founders kept talking past each other. Someone would ask how much was left over last year and get back an answer about how much was sold. One side was asking about what remained and the other was answering about what came in. What counted as an expense also varied by person, so two companies could not be put side by side.

Net income exists to pin down a single meaning for "left over." The order in which costs come out is fixed in advance, and only the last line — the one that has passed through every subtraction — gets called profit. That line sits at the bottom of the income statement, the table that shows what a company earned and kept over a stretch of time. The further down that table you read, the more has been taken out.

Start at revenue and subtract costs in a set order; whatever survives to the bottom is net income. Each subtraction produces a differently named profit, so the four steps happen in sequence.

1. Subtract cost of goods sold (COGS) from revenue. COGS is the money spent directly on producing the revenue itself. At a software company that means server bills and payment processing fees. What remains at this point is gross profit.
2. Subtract operating expenses. These are the everyday costs of running the business — salaries, rent, and advertising. What remains is operating profit, which shows whether the core business itself makes money.
3. Add and subtract the gains and losses that come from outside the core business. Interest earned on deposits gets added, interest owed on loans gets taken out. The figure at this point is pretax profit.
4. Subtract corporate income tax. What remains is net income.

Pagedeck's last year makes the sequence concrete. Revenue of $3,000,000 less COGS of $600,000 leaves gross profit of $2,400,000. Taking out $2,250,000 of operating expenses leaves operating profit of $150,000. Interest paid ran $30,000 higher than interest received, so pretax profit came to $120,000, and after $30,000 of tax the net income was $90,000 — three percent of revenue.

That $90,000 is not cash that showed up in the bank. Accounting runs on accrual accounting, which records a transaction on the day it happens rather than the day money moves. Work delivered in December and billed for payment in February counts in December's revenue while December's bank account sees nothing.

Read the ratio before the amount. Net income divided by revenue is the net profit margin, and Pagedeck's $90,000 against $3,000,000 of revenue is three percent.

What counts as a healthy margin depends on the industry. A retailer that buys goods and resells them runs normally at one to three percent, while an established software company can reach fifteen to twenty-five percent, because serving one more user costs almost nothing extra. Four percent is a good year for the retailer and a sign of an immature business for the software company.

In an early subscription business a negative number is closer to normal. The cost of acquiring a customer leaves the bank this month while the fees that customer pays arrive over several years, so the losses come first by design. What matters is the shape of the loss, not its existence. If revenue is climbing while the loss narrows, the plan is working. If revenue climbs and the loss grows with it, the business loses money on every sale.

One year in isolation is not enough either. Net income jumps around on events that have nothing to do with the core business. A company that sells a building for $1,500,000 posts a record year, and that event does not repeat. So the figure gets read three years at a time, and any year that spikes gets checked against operating profit to see whether it came from the work the company actually does.

"Revenue is up 40 percent and net income barely moved. We need to find where it's leaking."

Costs grew alongside revenue, so the expense lines should be examined one by one.

"This quarter's net income came from clearing out the old office deposit, so it won't be there next quarter."

The profit didn't come from the core business, so nobody should read it as a trend.

"We're not targeting net income this year. Anything left over goes into hiring."

Asking for agreement in advance to run at a loss in exchange for growth.

At Pagedeck, Grace opens the income statement for the whole team once the quarter closes. She reads down from the top line and points out where each chunk came out. Last quarter Ravi asked what would happen if the advertising budget doubled, and Grace answered by pointing at that line: the company keeps about $22,000 a quarter, and another $40,000 a month of advertising turns that line negative immediately.

The line doesn't make the decision, though. In board material the numbers Grace spends longer on are the growth rate and the number of months the remaining cash covers. Net income is where she checks whether the business as currently built can feed itself.

The most common mistake is reading net income as cash added to the bank. Profit sounds like money in hand, so the assumption is natural. But net income is calculated on an accrual basis, so revenue includes invoices nobody has paid yet, while costs that never moved any cash have been subtracted. A year with $90,000 of net income and $230,000 of overdue receivables leaves the bank balance smaller than it started. It is how a company that builds its hiring plan on profit ends up borrowing to make payroll. Where the cash actually went is a question for the cash flow statement.

The opposite mistake is just as common: reading a negative number as a company on its way out. "Loss" sounds like failure. But an early subscription business spends first and collects later by design. Two things separate a planned loss from a broken one. How many months the remaining cash covers, and whether a customer pays more over their lifetime than it cost to acquire them. If both hold, the loss is a plan. If either fails, the structure needs fixing regardless of the size of the loss.