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Running a business

What is net income and how does it affect your bottom line?

If you’re in business, you know there are dozens and dozens of accounting terms that relate to the financial health of your small business. At first, it can be a bit overwhelming. Fortunately, you don’t have to be a CPA to get a handle on the basics. Even so, getting to know some key terms is extremely helpful. That’s because if you don’t, you could suddenly find yourself dangerously short of cash or up the creek with the ATO.

Two of the most common and most useful terms you’ll come across in managing your day-to-day business finances are “net revenue” and “net income”.

How are net and gross different?

The key to making sense of net income and net revenue is understanding the difference between “net” and “gross.”

Gross income is the total amount of income your company earns during the year. From a financial standpoint, the term “gross” means a beginning amount before any expenses, deductions or withholdings are subtracted. Net income consists only of the profit your company makes after subtracting business expenses and other deductions from your gross income.

For example, let’s say you have $100,000 in sales. Your gross business income would be $100,000. But your net income must take into account expenses like salaries, rent, benefits, etc., as well as any deductible expenses, like car allowances or business travel. Let’s say all of these expenses amount to $70,000. The $30,000 that’s left is your net income or profit.

Let’s dig deeper into net revenue and net income, and how they differ from gross revenue and gross income. We’ll also take a look at why the differences between net revenue and net income are so important to your company’s profitability.

What is net revenue?

Net revenue (or net sales) refers to money earned by your company during the course of doing business. For example, if you own a shoe store, the money you make from selling shoes to your customers is your revenue.

Almost every company is in business to sell either a product or a service. Sales or revenue is the income you make from your core business, although you may generate some income from other sources, like renting out part of your office space. Net revenue is your company’s total sales revenues, after subtracting things like sales discounts, returns, etc.

For example, let’s say your company sells 100 items for $100 each. That would make your gross revenue $10,000; but, suppose you offer discounts to seniors or students if they fill out a coupon and hand it to you when they pay. If those discounts amount to $2,000, your net revenue is reduced to $8,000. If some unhappy customers demand refunds or—perish the thought—bounce cheques totaling $500, your net revenue is now $7,500.

What is gross revenue?

Gross revenue shows both money made from the sale of products and services, as well as revenue generated from interest, sales of property and equipment, sales of shares, etc.

So let’s say you have an interest-bearing transaction account or maybe you lease out part of your parking lot to another business. If the monthly income from these two items is $500, you can add this to your net revenue of $7,500 for gross revenue of $8,000.

In simple terms, gross revenue refers to all of the sources of revenue your business earns through normal operations. Your company’s sales are only one component of your gross revenue. Another common source of gross revenue may include any dividends or interest from investments your company holds.

What is net income?

When you hear the term “bottom line,” it really means net income, also referred to as net profit. This is because it appears as the final item (or bottom line) on your company’s income statement. Net income is the amount of profit a business has left over after paying off all of its expenses, and it’s important to measure your company’s profitability.

Your company can calculate its net income by taking sales revenue and subtracting cost of goods sold, general expenses, operating expenses, interest and taxes, depreciation, and other similar expenses.

Although net income almost always appears as the final item on an income statement, some companies may have a separate section at the bottom of their statement that reconciles their beginning and ending retained earnings through net income and dividends.

What is gross income?

Gross income, also known as gross margin or gross profit, is the total sales by your business minus cost of goods sold. It does not include, however, any other costs you incur when running your business.

Gross income shows up on your income statement as a starting figure. It’s then reduced by discounts, price adjustments, returns, and any other deductions to determine net income or net earnings.

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How do you calculate net income?

To find net income, you start with net revenue. Next, deduct the cost of doing business, which includes materials, rent or mortgage payments, the salaries you pay your employees, utility bills and so on. That yields what is called your taxable income.

Taxes are a percentage of income, so, once you figure out what you owe in taxes, subtract that amount from your income. The remainder is your net income. Net income is found by using the following calculation:

Net Income = total revenue – (costs of goods sold + operating expenses + other gains or losses + other expenses + depreciation + interest expense + taxes)

Everything in the parenthesis of this formula makes up your total cost of doing business. To make it even clearer, let’s look at an example of net income on an annual basis.

If your annual net revenue is $120,000, your total cost of doing business is $55,000, then your net income is $120,000–$55,000, which equals $65,000.

Net income also comes into play when applying for a loan or otherwise trying to secure funding for your business. It’s used by investors or banks when determining a company’s eligibility. For shareholders, low or negative net income can mean a big drop in the value of a company’s shares.

Net income and gross income on your pay cheque

In terms of personal finances and payroll, net income and gross income are also terms you’ll run into. The most common place you’ll see them is on your pay cheque or your employees’ pay cheques.

Gross income and gross pay

Gross income is also called gross pay. It’s the number of hours worked, multiplied by an hourly rate (unless you or your employees are salaried). Adding up all of your gross income for the year gives you your annual gross income.

Net income and net pay

Net income, also sometimes called take-home pay or net pay, is your gross income minus any deductions and withholdings from your pay cheque. These deductions might include income tax or overpaid wages. Net income is the amount of money that goes into your bank account unless you cash your cheque instead.

What’s the difference between net income and net revenue?

The difference between your company’s top and bottom line is the difference between net revenue and net income. Net income is profit or what’s left over after you pay all expenses and account for all gains, losses, taxes and other obligations.

Net revenue is money earned from doing your core business. This doesn’t take into account, however, interest earned or money that comes in from other sources like shares.

Net revenue and net income are important figures that demonstrate a company’s financial stability. Both net revenue and net income show up on your income statement and are typically included in reports presented to banks or investors when your company is seeking money for expansion, additional materials or new equipment. This is also important as it shows how much your business is earning above and beyond any expenses you may incur during the sales process.

Understanding these differences

If you understand your income statement (also called your profit and loss statement or P&L), you know that the top line is net revenue or sales. This is the money you make from the goods or services your company provides to its customers, minus any returns or other allowances, like incentives you give customers to keep an item rather than return it.

Further down, you will see various amounts taken out or sometimes added in to show income and expenses. At the bottom of your income statement is where you’ll find net income, which is the net profit you can enjoy after all expenses, interest, taxes and other costs have been paid and deducted.

Understanding the differences between net income and net revenue is important because if more money went out of your business than came in, your company will see a net loss. However, if more money came in than went out, your company will see a net gain. Time to celebrate.

The bottom line

In summary, net income is a company’s total earnings or profit, and net revenue is the amount of income generated from the sales of goods or services related to a company’s core business. Your company relies heavily on both when determining its own financial strength.

Growth in revenue is a fundamental factor associated with strong companies; however, there are factors that come into play which can make maintaining growth a bit tricky. Seasonal changes for retail businesses can have an effect on a company’s profits, as sales are often stronger during the holidays.

Maintaining high margins and keeping operating expenses to a minimum are also good strategies to remain profitable. It’s also always a good idea to track trends in revenues and expenses. If you notice several years of declining revenue, it may be a sign that your company is struggling.

When using accounting software like QuickBooks Online, you can easily generate your company’s income statement and see how net income and net revenue affect your bottom line.

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