Net income, or profit, is the money a business has left over after paying all of its expenses during an accounting period. It equals revenue minus expenses. If your small business’s expenses exceed its revenue, it has a net loss. One of the primary goals of a business is to maximize its net income, which comes with several advantages.
When you produce a steady stream of profit, your business can continue operating comfortably and can avoid potential financial problems. Without net income, a business can survive for only so long before it must raise additional funding or close its doors. For example, if you consistently generate around $900,000 in annual revenue and $750,000 in expenses, you produce annual net income of $150,000. If your expenses were $1.1 million, you would have a $200,000 annual shortfall, which would make it difficult to continue doing business.
Net income that you reinvest in your business is a form of internal financing generated from your own operations. This type of financing is typically cheaper than that from external sources, such as a bank or investor. You do not need to pay interest on reinvested profits or pay them back to any creditors. Assume you plow $275,000 of net income back into your operations. That money is yours to use without any additional costs or restrictions.
Although a profitable company might not need much, or any, outside financing, its net income can help it obtain external funding if it desires. In general, banks and investors are more willing to give capital to a company that has strong profits, because they expect it to afford its loan payments and generate good investment returns. For example, a small business with five consecutive years of increasing net income will likely qualify for a loan more easily than one with consistent losses.
Investors and potential acquirers commonly estimate a company’s value by multiplying its annual net income by a market-designated multiple. This multiple comes from data about similar, recently sold companies. With all else being equal, the higher your company’s net income, the more it is worth. For instance, if businesses in your industry currently sell for 10 times annual net income and your small business generates $400,000 in annual profit, it would be worth approximately $4 million. Without net income, your business would probably be worth much less.
