When people use the phrase "the bottom line", they mean the ultimate outcome of an activity, event or project. In the business world, that's exactly what bottom line profitability means. You can make a good argument that the bottom line is the most significant number businesspersons and investors should be aware of because it is the ultimate measure of the success or failure of a business enterprise.
The bottom line is the amount of money a business gains or loses. It appears as the last item on a firm's income statement, which is how the phrase originated.
Overview: Bottom Line Profit
When you look at a company's income statement, the bottom line is usually labeled "net income", although it is also referred to as net profit or net earnings. Net income is the amount remaining after all costs and taxes are subtracted from the gross sales a business generates during a year or other accounting period.
Another way to look at net income is in terms of top line vs. bottom line. The top line definition is simply gross sales. As you might guess, it appears first on the income statement. Expenses and adjustments appear below the gross sales. The bottom line is the difference between gross sales and the aggregate total of all other amounts reported on the income statement.
There are three intermediate profit-related figures that appear on the income statement. Each provides valuable information to business owners and investors, but they should not be confused with the bottom line. The first is gross profit or gross income, which is the amount remaining once direct costs are subtracted from sales. Operating income is what is left after operating costs are deducted from gross profit and pre-tax income is equal to operating profit less other expenses except for income taxes.
Importance of the Bottom Line
The most obvious reason the bottom line matters is that it states the profitability and therefore the overall performance of a business. Ultimately, a business must make a profit to survive and net income tells you how much money the firm is earning or losing. For investors, the bottom line reveals how much is available to pay dividends or to reinvest to make the business grow.
Lenders pay close attention to the bottom line as well. Suppose a banker is considering loaning a firm $500,000 to expand its operations. Net profit is a critical number for the banker because it tells her if the company is in a position to repay the loan in a timely manner.
Bottom Line Calculation
The bottom line is the end result of a series of calculations that begin with the gross sales of a business. The details of these calculations make up the information reported on the firm's income statement. Suppose a shoe retailer, ABC Footwear, has annual sales adjusted for returns and discounts of $5 million. The direct cost of acquiring shoes and other goods to sell, also called cost of goods sold, totals $3 million. After subtracting the cost of goods sold, the company has a gross profit of $2 million.
The next step is to determine operating income, which is the amount remaining after selling, administrative and general costs necessary to operate the business are subtracted from gross profit. If these operating expenses equal $1,250,000 for ABC Footwear, this amount is subtracted. The operating income equals $750,000.
Interest, depreciation and other expenditures not related to a company's primary business operations are subtracted next. Non-operating revenue such as investment earnings may be added. Once these items are calculated, the amount remaining is the pre-tax income. Local, state and federal taxes are subtracted, leaving net income — the bottom line.
Suppose ABC Footwear has interest costs and depreciation allowances that total $150,000 and pays income taxes of $200,000. Once these amounts are subtracted, the company's bottom line profit equals $400,000.