Bottom Line: Net Income and EPS#

The "bottom line" is where the income statement journey ends. Net income and earnings per share (EPS) are the numbers that get the most attention—but they require careful interpretation.

Net income is what's left after ALL expenses. It's the company's profit that can be paid to shareholders as dividends or retained to grow the business.

From Operating Income to Net Income#

Below operating income, two more items affect the bottom line:

Interest (Net)#

Item	Impact
Interest Expense	Cost of debt (subtracted)
Interest Income	Earnings on cash holdings (added)
Net Interest	The difference

Why It Matters: A company with heavy debt will have significant interest expense, reducing net income even if operations are strong.

Income Taxes#

Income tax expense reflects taxes owed on profits:

Effective tax rate varies by company
Tax strategies can significantly impact net income
One-time tax benefits or charges can distort results

Effective Tax Rate

Effective Tax Rate = Income Tax Expense ÷ Pre-tax Income

Compare this to statutory rates and competitors. Very low rates might indicate unsustainable tax strategies.

The Net Income Calculation#

Net Income = Operating Income - Net Interest Expense - Income Tax Expense

Complete Example#

Line Item	Amount
Operating Income	$100,000
Interest Expense	($15,000)
Interest Income	$2,000
Pre-tax Income	$87,000
Income Tax (25%)	($21,750)
Net Income	$65,250

Net Profit Margin#

Net Profit Margin = (Net Income ÷ Revenue) × 100

This tells you what percentage of each revenue dollar becomes profit.

Company	Revenue	Net Income	Net Margin
Company A	$500M	$75M	15%
Company B	$500M	$25M	5%

Same revenue, very different profitability. Company A is three times more efficient at turning revenue into profit.

Industry Comparisons#

Industry	Typical Net Margin
Software	15-25%
Pharmaceuticals	15-25%
Banking	15-25%
Consumer Staples	5-15%
Retail	2-5%
Airlines	2-8%
Grocery	1-3%

EPS translates total company profit into per-share terms:

EPS = Net Income ÷ Weighted Average Shares Outstanding

Basic EPS#

Uses the actual average number of shares outstanding during the period.

Diluted EPS#

Accounts for potential future shares from:

Stock options
Convertible bonds
Convertible preferred stock
Warrants

Always Use Diluted EPS

Diluted EPS is the more conservative (and realistic) measure. It shows what EPS would be if all potential shares were actually issued. Companies can have millions of stock options outstanding that could significantly dilute shareholders.

EPS Example#

Item	Amount
Net Income	$10,000,000
Shares Outstanding	5,000,000
Potential Dilutive Shares	500,000

Basic EPS	$2.00 ($10M ÷ 5M)
Diluted EPS	$1.82 ($10M ÷ 5.5M)

The 9% difference between basic and diluted EPS is significant!

EPS Growth#

EPS growth is one of the most watched metrics. But be careful—EPS can grow for different reasons:

Good EPS Growth#

Revenue growth
Margin improvement
Genuine business expansion

Artificial EPS Growth#

Share buybacks (fewer shares = higher EPS)
One-time gains
Lower tax rates
Cost cutting that hurts long-term growth

Check the Source

When you see EPS growth, ask: Is it from growing profits, or just from fewer shares? Both can be valid, but they tell different stories about the business.

Quality of Earnings#

Not all earnings are created equal. High-quality earnings are:

Signs of High-Quality Earnings#

Sustainable and repeatable
From core business operations
Supported by cash flow
Consistent with revenue growth
Using conservative accounting

Signs of Low-Quality Earnings#

One-time gains boosting results
Aggressive revenue recognition
Earnings growing while cash flow declines
Frequent "adjustments" and non-GAAP presentations
Heavy reliance on tax benefits

The Cash Flow Test#

Operating Cash Flow vs. Net Income

Scenario	What It Suggests
OCF > Net Income	High quality (cash exceeds accounting profit)
OCF ≈ Net Income	Normal relationship
OCF < Net Income	Investigate (profits not turning into cash)
OCF << Net Income	Red flag (earnings may be low quality)

The Ultimate Test

If a company reports profits but consistently has negative or declining operating cash flow, the earnings might be accounting creations rather than real economic profits.

Common EPS Manipulations#

Be aware of these tactics:

Buying shares right before quarter-end to boost EPS
Using debt to fund buybacks

One-Time Items#

Gains from asset sales
Insurance recoveries
Releasing reserves

Accounting Choices#

Aggressive revenue recognition
Understating expenses
Changing depreciation assumptions

Analyzing Net Income Trends#

Pattern	What to Investigate
Growing revenue, growing net income	Healthy—verify with cash flow
Growing revenue, flat net income	Margin compression—why?
Flat revenue, growing net income	Cost cuts—sustainable?
Declining revenue, growing net income	Red flag—how is this possible?

Key Takeaways

Net income is profit after all expenses including interest and taxes
Net profit margin shows overall efficiency in generating profit
Diluted EPS is more realistic than basic EPS
EPS growth can come from genuine business improvement or financial engineering
High-quality earnings are sustainable, from core operations, and backed by cash flow
Always compare net income to operating cash flow to verify quality
Be skeptical of earnings that grow faster than revenue or cash flow