What is the Bottom Line?
The bottom line represents the number of sales dollars remaining after all operating expenses, interest, taxes and preferred stock dividends (but not common stock dividends) have been deducted from a company's total revenue.
How Does the Bottom Line Work?
The bottom line is also referred to as net income, net profit, or net earnings. The formula for the bottom line is as follows:
Total Revenue -Total Expenses = Net Income
The bottom line is found on the last line of the income statement, which is why it's called the bottom line. Let's look at a hypothetical income statement for Company XYZ:
Income Statement for Company XYZ, Inc.
for the year ended December 31, 2008
Total Revenue $100,000
Cost of Goods Sold ($ 20,000)
Gross Profit $ 80,000
Utilities $ 5,000
Depreciation $ 5,000
Total Operating Expenses ($ 30,000)
Interest Expense ($ 10,000)
Taxes ($ 10,000)
Bottom Line $ 30,000
By using the formula we can see that the bottom line = $100,000 - $20,000 - $30,000, - $10,000 - $10,000 = $30,000
Why Does the Bottom Line Matter?
The bottom line is one of the most closely followed numbers in finance, and it plays a large role in ratio analysis and financial statement analysis. Shareholders look at the bottom line closely because it is the source of compensation to shareholders of the company, and if a company cannot generate enough profit to compensate owners, the value of shares will plummet. Conversely, if a company is healthy and growing, higher stock prices will reflect the increased availability of profits.
One of the most important concepts to understand is that the bottom line is not a measure of how much cash a company earned during a given period. This is because the income statement includes a lot of non-cash expenses such as depreciation and amortization. To learn about how much cash a company generates, you need to examine the cash flow statement.
Changes in the bottom line are endlessly scrutinized. In general, when a company's bottom line is low or negative, a myriad of problems could be to blame, ranging from decreasing sales to poor customer experience to inadequate expense management.
The bottom line varies greatly from company to company and from industry to industry. Because the bottom line is measured in dollars and companies vary in size, it is often more appropriate to consider the bottom line as a percentage of sales, known as 'profit margin.' Another common ratio is the price-to-earnings ratio (P/E), which tells investors how much they are paying (the stock's price) for each dollar of the bottom line the company is able to generate.
If you'd like to read more in-depth information about using the bottom line and other income statement line items, check out the following:
Income Statement definition -- learn about this all-important financial statement used to calculate profitability.
Operating Income definition -- learn how operating income is related to the bottom line.
Price-to-Earnings Ratio definition -- learn how to calculate and use the P/E ratio, one of the most used ratios in investing.
Financial Statement Analysis: The Income Statement -- learn the most important components of the income statement and how to use them to determine a company's profitability.
How to Use Margin Analysis as an Investment Tool -- learn how to use the three most common profit margin ratios to find the best investments.