Therefore, the formula for calculating net income is revenue minus expenses. Rearranging the equation, if we know total revenue and net income, we can calculate total expenses by taking total revenue and subtracting net income. Now, we'll turn to the owners' equity to determine net income.
Figuring out net income from the owners' equity section of the balance sheet
At the end of the period, the company's profit or loss can't just stay on the income statement. The income statement is a summation of the revenue and expenses for a given period. It doesn't show what happened in prior periods or what the company owns or owes.
To reflect how the company's profit or loss impacts what it owns or owes, the accountants must transfer the profit or loss to the balance sheet. In this case, net income transfers to the owners' equity section of the balance sheet. A profit increases owners' equity, and a loss decreases it.
The challenge for us is that there are other factors that can impact the owners' equity section. There are three fundamental considerations -- a profit or loss, a distribution to shareholders like a dividend, or raising new equity capital. Therefore, we must account for each of these situations to accurately calculate the net income for the period.
To do this, we'll look to the company's statement of stockholder's equity on the balance sheet. This will show us the beginning owners' equity, ending owners' equity, and any changes from capital distributions, new capital issuances, and changes from profits or losses.
First, add together the ending owners' equity and any capital distributions to shareholders. Typically, capital distributions will be dividends paid and treasury stock purchased.
Next, take that sum and subtract beginning owners' equity and any new capital raised. New capital will generally be shown as shares issued.
If the result is positive, that amount was the company's profit for the period. If it is negative, that was the company's net loss.
An example to see the calculation in action
Let's assume that a company had total revenue of $1 million, and we found the following information from the owners' equity section of its balance sheet.
