What are Net Earnings?
Net earnings represent the amount of sales revenue left over 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 Do Net Earnings Work?
Net earnings are found on the last line of the income statement, which is why it's often referred to as the bottom line. Let's look at a hypothetical income statement for Company XYZ:
By using the formula we can see that Net Earnings = $100,000 - $20,000 - $30,000, - $10,000 - $10,000 = $30,000
Why Do Net Earnings Matter?
Net earnings are 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 net earnings closely because they are 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 net earnings are 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 net earnings are endlessly scrutinized. In general, when a company's net earnings are low or negative, a myriad of problems could be to blame, ranging from decreasing sales to poor customer experience to inadequate expense management.
Net earnings vary greatly from company to company and from industry to industry. Because net earnings are measured in dollars and companies vary in size, it is often more appropriate to consider net earnings 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 net earnings the company is able to generate.
If you'd like to read more in-depth information about using net earnings and other income statement line items, check out the following:
-- learn about this all-important financial statement used to calculate profitability. definition
-- learn how definitionoperating income is related to net earnings.
-- learn how to calculate and use the P/E ratio, one of the most used ratios in definitioninvesting.
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.