When considering the financial health of a company, net income is perhaps its most closely scrutinized figure. A healthy net income means a good return to company shareholders and the likelihood that investors will continue to support the company. On the other hand, a weak net income raises immediate red flags of warning to investors. A useful way to look comparatively at companies within a specific industry is to examine their net income as a percentage of their sales.
When a company reports that it has "$6,000,000 in sales last year," this is not the amount of money the company made that year. It is simply the company's "gross revenue," or the amount of money it took in. Gross revenue is the starting point for any company's income statement. Just because the figure may be high, though, does not necessarily mean that the company is profitable.
Companies have various types of expenses that are divided into two broad categories: "cost of goods sold" (COGS) and "operations." For instance, a book printer must buy supplies like paper and ink to print customer's books. These expenses are listed under COGS. The printer, however, also has to pay staff salaries, rent for the print shop, utilities, taxes, interest expenses if equipment is being leased, and so forth. These are all considered operational expenses.
A company's net income is simply the dollar amount remaining after its expenses have been subtracted from its gross revenue. For example, if a company has a gross revenue of $1,000,000 and expenses of $800,000, their net income is $200,000 ($1,000,000 minus $800,000 equals $200,000). A company's net income is their "bottom-line," or how much money they are actually making for their efforts. The last line of a company's income statement is the company's net income.
If a company's net income is viewed as a percentage of its gross revenue, you can see its profit margin. In the scenario given above, the company would have a 20 percent profit margin, since a $200,000 net income is 20 percent of the company's $1,000,000 gross revenue. Different industries have different rules for typical profit margins, and a specific company's profit margin can inform it about how well or poorly it is doing. For instance, if the average profit margin for a large-scale winery is 25 percent, and a specific winery has a 12 percent profit margin, the company needs to take a close look at what it may be doing wrong or what it could be doing better to increase its profit margin.
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