Whether you're looking at your own company's books or contemplating an investment in someone else's firm, a look at the company's net income can give you a quick idea of how well it's doing. A company's net income is like the take-home pay on a pay stub: It's the amount a company keeps after deducting its expenses. The income statement lays out that information for you, but you can also calculate it from the balance sheet.
How a Balance Sheet Works
The balance sheet shows a company's health by listing its current assets, liabilities and equity. In simple terms, assets are things the company owns, its liabilities are the things it owes, and the equity is what's left over. It's very much like the math of home ownership: Your home is the asset, the amount you owe is the liability, and your equity is the difference in their value. All three change constantly, and a company's balance sheet is a snapshot of the relationship between assets, liabilities and equity at a particular moment in time. The assets and liabilities must balance, hence the term "balance sheet." It's very much like balancing your checkbook, but on a larger scale.
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Get To the Bottom of It
To start with, go to the bottom of the company's balance sheet and look for a line called Total Equity. Now compare that to the same line from the previous quarter's or previous year's balance sheet. The difference between them is the starting point for determining the company's net income. An increase in the company's equity generally comes from an operating profit and a decrease comes from an operating loss, so if the company's equity last year was $50,000 and this year it's $75,000 you can conclude that it generated $25,000 in net income. That's only partially true, though, because a couple of other factors affect that bottom line.
Money In, Money Out
The company's equity can change for reasons unrelated to operating revenues. If your business is a startup, for example, equity could increase because you've increased your investment in the business or successfully landed some venture capital. On the other hand, equity could decrease because you've finally reached the stage where you can begin taking money from the company. To arrive at the company's net income, then, you'd start with the difference between last year's total equity and this year's total equity and then subtract the amount of any new investment. Finally, you'd add back in any withdrawals from the total equity — whether that be money you've taken from your own company, or dividends paid by a corporation to shareholders — to arrive at the actual net income.
- U.S. Securities and Exchange Commission: Beginner's Guide to Financial Statements
- Investopedia: Reading the Balance Sheet
- Accounting Coach: How Are the Balance Sheet and Income Statement Connected?
- Accounting Coach: What is Net Income?
- Fox Business: How to Calculate and Understand Your Balance Sheet