As you begin to analyze potential investments, you'll likely spend a lot of time staring at financial statements, trying to determine the potential profitability of a company. The net income and stockholders' equity are two concepts that are crucial to this determination. While both numbers are very similar in concept, the values they describe are very different, and it's vital to your analysis to understand the difference between the two.
Net Income Defined
Net income, sometimes referred to as net profit, is simply defined as revenue minus expenses for a particular period. Revenue is all the cash that the company took in, and expenses are what it put out -- cost of goods sold, salaries, equipment and other expenditures. Depending on the report you're reading, net income may or may not include taxes and interest expenses, but this should be fairly easy to figure out. It is important to understand that net income is specific to the reporting period -- one year in the case of an annual report, and the calculation only includes the money that was made or spent during that year.
Stockholders' equity is also referred to as shareholders' equity, or simply SE, and is the corporation equivalent to owner's equity in a sole proprietorship. SE is a snapshot of a moment in time, and is a bigger picture than net income because it looks at the company as a whole: everything it owns and everything it owes. SE adds up buildings, equipment, inventory and other assets and subtracts the total of debts, taxes and any other liabilities -- it is the estimated value of the company if it were liquidated today.
Relationship Between Net Income and SE
When a company has a net income, it can do two things: pay that money out to shareholders or keep it for reinvestment into the business. Many companies do some combination of the two. The portion of net income that is kept for the business is known as retained earnings. These retained earnings become an asset of the company, and are added to the asset portion of the SE equation.
Using Net Income and SE in Analysis
You can review both the net income and the SE over time to determine whether they are increasing or decreasing and why. You can also use these two numbers in ratios to compare the health of one company to another. Net income per share (net income compared to total outstanding common stock) is one such ratio. Another common ratio is the debt-to-equity ratio, where total liabilities are compared to SE. The return on equity compares the net income to SE for another valuable measurement.
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