Net Income (2)
Posted on January 28, 2009 - Filed Under Finance
The proportion of net income paid out to owners is called the payout ratio, while the proportion retained within the business is called the retention ratio. Thus, if Sunnyvale were an investor-owned clinic, and if it
paid $2,000,000 in dividends in 2004, its payout ratio would be $2,000 / $7,860 = 0.254 = 25.4% and its retention ratio would be ($7,860 ? $2,000) / $7,860 = $5,860 / $7,860 = 0.746 = 74.6%. Note that net income only has two places to go—to owners as dividends or to the business as retained earnings—so Retention ratio = 1 ? Payout ratio and Payout ratio = 1 ? Retention ratio.
Net income measures profitability as defined by GAAP. In establishing GAAP, accountants have created guidelines that attempt to measure the economic income of a business, which, in all honesty, is a very difficult task because economic gains and losses often are not tied to easily identifiable events. Furthermore, because of accrual accounting and the matching principle, the fact that Sunnyvale reported net income of $7,860,000 for 2004 does not mean that the clinic, on net, experienced a cash inflow of that amount. This point is discussed in greater detail in the next section.
Before moving on, note that some not-for-profit income statements contain a section below the net income entry that reconciles the reported net income with the net assets (i.e., equity) reported on the balance sheet.
In essence, the entire amount of net income of not-for-profit organizations must be reinvested in the business, so the amount of net assets reported on the balance sheet, after various adjustments, must increase over the year by the amount of net income. The important relationships between the income
statement and the balance sheet are considered in more depth in Chapter 4.
Taken From : HEALTHCARE FINANCE
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