How to Calculate Net Income
Posted by Frank Gogol in Work & Income | Updated on June 20, 2023
“It’s good for the bottom line!”
This phrase has become part of the way we speak in casual conversations. When someone refers to the bottom line, they are referring to the most important thing – the final result or outcome.
But did you know this phrase comes from the world of business accounting? The bottom line on an income statement shows a company’s net income. Net income is an essential indicator of a company’s profitability and success.
You can find out more about what net income is and how to calculate net income below.
What Is Net Income?
At its most basic, your company’s net income is your company’s total profits after deducting business expenses.
Net income can either be positive or negative. If you have more income than expenses, you will have a positive net income. Your company has made a net profit. If your expenses outweigh your income, you will have a negative net income. Your company has then made a net loss.
The same is true for individuals. Your net income is the amount of money you earned after tax.
Net income is particularly important in the business context. The net income of a company represents its profitability and can influence whether it gets investors or loans. Net income also represents the amount of money your company has available for growth. It is the amount of money you have leftover to pay shareholders, invest in new projects or equipment, pay off debts or save for future use.
Net income is recorded on your business’s income statement. The income statement is one of three main financial statements companies use.
An income statement shows the profitability of your company. It reports your business’s profits and losses over a specific period. Income statements basically outline the process of calculating net income.
Total revenues, cost of goods sold, gross income, expenses, taxes, and net income are all line items on the income statement. The reason net income is referred to as “the bottom line” is because net income is the final line of the income statement.
Understanding Net Income
Your company’s income is determined by your sales and any other revenue streams you may have. Incoming revenue is vital to business growth, but it is not the most accurate way of measuring the success of your business. After all, if you make a lot of income but still spend more money than you earn, your business would still be in trouble.
To know whether your company is successful, you need to know if it is making a profit after you have deducted all of the expenses incurred by the business. Profit is calculated by determining your company’s net income.
Calculating Net Income for Businesses
To calculate net income for your company, start with the company’s total revenue. This is all of the company’s income – the money generated by normal business operations.
Next, you need to subtract your company’s expenses and operating costs. Types of business expenses you might have to include are operating expenses, payroll costs, rent, utilities, taxes, interest, certain dividends, depreciation, etc.
The value you’ve just calculated is your company’s earnings before tax. Subtract the amount of tax you pay from your earnings before tax.
The amount you have left is your company’s net income.
Gross Income vs. Net Income
The gross income of your company is the difference between all of the money your business made and all of the money your business spent to get that income. In a company that sells a product, your gross income is how much money your business has after deducting the cost of goods sold from total revenue. Gross income is the profit you make on the normal business operations of your company.
Net income takes it one step further by also subtracting other expenses your company may have incurred. Interest and tax, for example, don’t fall under the cost of sales, but your company still has to spend that money. Net income is your gross income after deductions and taxes have been subtracted.
For an individual, gross income is your pre-tax earnings. After you subtract the tax you have paid, you will get your net income.
Net Income on Tax Returns
In the United States, individual taxpayers submit a version of Form 1040 to the IRS to report annual earnings. This form does not have a line for net income.
On an individual’s tax returns, gross income and deductions are used to calculate your taxable income. The taxable income amount is used to determine your tax payable. If you subtract your tax payable from your gross income, you will find your net income. However, net income is not noted on individual tax forms.
Net Income on Paycheck Stubs
Most paycheck stubs have a line devoted to net income. This is the amount that your employer will pay into your bank account. Your individual net income is your gross income, minus taxes, and retirement and other contributions.
Net Income Formula
Now that you understand the fundamentals, let’s look at how to calculate net income.
Your company’s net income is your company’s total profits after deducting business expenses.
The formula for calculating net income is:
Revenue – Cost of Goods Sold – Expenses = Net Income
But as we saw above, revenue minus cost of goods sold is the definition of gross income. So we can simplify the formula above and say that:
Gross income – Expenses = Net Income
The simplest way to write this is:
Total Revenues – Total Expenses = Net Income
Using the formula above you can find your company’s net income for any given period.
Net Income Formula Example
To make it even easier, let’s look at an example. Let’s say you want to calculate your company’s net income for March, with the following numbers:
Total revenues: $60,000
Cost of goods sold: $20,000
- Rent: $6,000
- Utilities: $2,000
- Purchases: $1,000
- Payroll: $10,000
- Taxes: $2,400
- Interest expense: $1,000
Since we don’t already have a gross income value, let’s use the first formula:
Revenue – Cost of Goods Sold – Expenses = Net Income
We should add rent, utilities, purchases, payroll, taxes, and interest together to find the total of our expenses.
Expenses = $6,000 + $2,000 + $1,000 + $10,000 +$ 2,400 + $1,000 = $22,400
Using the values for revenue and cost of goods sold given above we find that:
$60,000 – ($20,000) – ($22,400) = $17,600 = Net Income
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Net income is known as the “bottom line” as it appears as the last line on the income statement once all expenses, interest, and taxes have been subtracted from revenues.
The net income of a company represents its profitability and can influence whether it gets investors or loans. Net income also represents the amount of money your company has available for growth. It is the amount of money you have leftover to pay shareholders, invest in new projects or equipment, pay off debts or save for future use.
Net income is easy to calculate – either complete an income statement or use the easy formula on how to calculate net income we explained above!