Definition and Examples of the Bottom Line
The bottom line refers to a company’s net income, which appears at the end of the income statement. If total expenses exceed revenue for the reporting period, the bottom line will show a net loss. If revenue is greater than total expenses, the bottom line will show positive net income. Understanding a company’s bottom line is vital if you’re analyzing financial performance. However, it isn’t the only metric you should consider as an investor. The stock market is what’s known in economics as a leading indicator. Investors base their decisions on their predictions for the future, rather than what happened in the last year or quarter. That’s why improvements to the bottom line don’t always cause share prices to skyrocket.
How the Bottom Line Works
The bottom line is the amount of money left after you subtract expenses from revenue. If the bottom line is positive for a reporting period, the company has net income. If it’s negative, the company has a net loss. To calculate the bottom line, start with the total revenue a company generated from selling its goods or services during a year or quarter. Sometimes total revenue is referred to as the top line. Next, deduct the cost of goods sold to arrive at the gross profit. Next, calculate operating expenses, which include things such as rent, utilities, and overhead. Subtracting operating expenses from gross profit gives you the company’s pre-tax income for the period, which is often referred to as earnings before interest and taxes, or EBIT. Finally, subtract taxes and interest on debt. The resulting net income or net loss is the bottom line.
What It Means for Individual Investors
The bottom line is important to investors because it shows whether a company is making a profit or losing money. It can be especially helpful to your investment decisions when you can analyze whether a company’s bottom line is improving or getting worse over time. However, the bottom line isn’t the only metric you should consider if you’re deciding whether to buy or sell a stock. Many investors believe in the EBIT method, or its corollary, the EBITDA (earnings before interest, taxes, depreciation, and amortization). Stripping away interest, taxes, depreciation, and amortization allows investors to focus more on what a business is earning from its regular operations. It’s essential to remember that past performance never guarantees future results, so you don’t want to invest solely on the basis of a company’s bottom line. You should only invest if you believe a company is well-positioned to deliver profits moving forward.
