Net Income
Net income is the bottom line — profit left for shareholders after every cost, interest payment, and tax dollar. It drives EPS, feeds retained earnings on the balance sheet, and starts the cash flow statement. But it is not cash, and understanding why is one of the most important concepts in finance.
What Net Income Represents
Net income is the company's accounting profit for the period. It follows GAAP rules, meaning it includes non-cash charges (depreciation, stock-based compensation, amortization) and recognizes revenue when earned rather than when collected.
This number flows to two places:
- Retained earnings on the balance sheet (net income minus dividends paid)
- Top of the cash flow statement, where it gets adjusted back to actual cash
Earnings Per Share (EPS)
Investors and analysts rarely look at net income in isolation. They divide it by shares outstanding to get EPS, making it comparable across companies of different sizes.
Basic EPS is straightforward:
Basic EPS = Net Income / Weighted Average Shares Outstanding
Diluted EPS assumes that all potentially dilutive securities convert into common shares. This gives you the worst-case per-share number.
Diluted EPS = Adjusted Net Income / (Weighted Average Shares + Dilutive Securities)
Diluted EPS is almost always lower than basic EPS. When an interviewer or analyst says "EPS" without qualification, they typically mean diluted.
From EPS to share price: The most common use of EPS is pairing it with a P/E multiple to get an implied share price. If EPS = $2 and the peer-group P/E is 20x, the implied share price is $2 × 20 = $40. This is the foundation of comparable-company valuation — and the basis of the worked example below.
What Are Dilutive Securities?
Dilutive securities are instruments that could become common shares, increasing the share count and reducing EPS:
- Stock options: Employees can buy shares at a set strike price. If the stock trades above the strike, those options are "in the money" and dilutive
- Convertible bonds: Debt that bondholders can convert into equity at a predetermined ratio
- Restricted stock units (RSUs): Shares promised to employees that vest over time
- Convertible preferred stock: Preferred shares that can be swapped for common
Dilution is slicing the pizza into more pieces. Same net income, more shares, smaller EPS. Diluted EPS assumes everyone who could claim a slice actually does — that's the conservative number analysts use.
For the diluted EPS calculation, only securities that would reduce EPS are included. If converting a bond would actually increase EPS (because the interest savings outweigh the extra shares), it's anti-dilutive and gets excluded.
The Share Price Calculation
Given: Revenue = $2,000, Gross Margin = 50%, SG&A (including D&A) = $500, Debt = $1,000, Interest rate = 10%, Tax rate = 25%, Shares outstanding = 100, P/E = 20x, EV/EBITDA = 7.5x.
Find share price and EBITDA.
- Gross Profit = $2,000 × 50% = $1,000
- EBIT = $1,000 − $500 = $500
- Interest Expense = $1,000 × 10% = $100
- EBT = $500 − $100 = $400
- Tax = $400 × 25% = $100
- Net Income = $400 − $100 = $300
- EPS = $300 / 100 = $3.00
- Share Price = $3.00 × 20 = $60
- Equity Value = $60 × 100 = $6,000
- Enterprise Value = $6,000 + $1,000 (debt) − $0 (cash) = $7,000
- EBITDA = $7,000 / 7.5 = $933
- D&A = EBITDA − EBIT = $933 − $500 = $433
This exact question appears at Moelis, Evercore, and PJT with slightly different numbers. The trick is knowing SG&A includes D&A — so EBIT is already after D&A. You solve for EBITDA by backing into it from EV/EBITDA, not from the IS directly.
GAAP vs. Non-GAAP Earnings
Many companies report both GAAP net income and a "non-GAAP" (or "pro forma") version that strips out certain charges.
Non-GAAP earnings typically exclude non-cash items like stock-based compensation, amortization of acquired intangibles, and one-time restructuring charges. The argument is that these items obscure the company's underlying operating performance. The counterargument is that SBC is real dilution, amortization represents real asset consumption, and "one-time" charges recur suspiciously often. Know both sides — interviewers test this.
A company can report positive EBITDA for a decade and still go bankrupt. EBITDA excludes CapEx, interest expense, and one-time charges. A company with massive CapEx requirements, high interest payments on leveraged debt, and a debt maturity wall it can't refinance will run out of cash regardless of how strong EBITDA looks. This is why cash flow matters more than any single earnings metric.
Net Income Is Not Cash
This is the single most important conceptual bridge between the income statement and the cash flow statement.
"Is net income the same as cash?" No. Net income includes non-cash charges (D&A, SBC) and uses accrual timing. A company can be profitable and still run out of cash. The CFS starts with net income and adjusts back to actual cash.
Three reasons net income diverges from cash:
- Non-cash charges: D&A, stock-based compensation, and impairments reduce net income but don't cost cash this period
- Working capital timing: Revenue recognized before cash is collected (accounts receivable up = cash out). Expenses recorded before paid (accounts payable up = cash saved)
- CapEx: Buying a $50M factory hits the cash flow statement immediately but only trickles through the IS as depreciation over many years
The cash flow statement exists to reconcile this gap — covered in the next section.
Key Takeaways
- Net income is accounting profit, not cash — it includes non-cash items and accrual-based timing
- Basic EPS divides net income by actual shares; diluted EPS assumes all dilutive securities convert
- Dilutive securities (options, convertibles, RSUs) increase share count and reduce per-share earnings
- The gap between net income and cash comes from non-cash charges, working capital changes, and capital expenditures
- Net income flows to retained earnings (balance sheet) and is the starting point of the cash flow statement (CFS)