What is net income? Formula, calculations, and examples

Net Income is one of the critical components of your business’s three basic financial statements. Tracking net income helps you understand the financial health of your business.

increasing net income indicates efficiency, while decreasing net income may indicate increasing costs or falling revenues.

Furthermore, creditors track the net income figure to ensure that you have enough money to pay your debts. Whereas, investors would want to have an understanding of the amount of money left after paying dividends for the investment.

As a small business owner, it is important to track net income and understand its impact on the bottom line of your business.

In this article, you will learn what net income is, how to calculate net income, and the effect of net income on your bottom line.

What is Net Income?

Net income is a company’s profit after business expenses are accounted for. It’s also referred to as net profit, net earnings, and the bottom line. To find your net income, you’ll need to subtract the following business expenses from your sales revenue:

• Cost of goods sold (COGS)
• Operating expenses
• General expenses
• Taxes
• Interest
• Depreciation
• Any other expenses

Your net income is typically found on the last line of your company’s income statement, which is why it’s often referred to as your bottom line. 

Let’s now understand some of the basic terms associated with net income to have a clear understanding of its concept.

Direct Expenses

Direct expenses are the expenses that can be directly attributed to a particular cost object. That is, these are the expenses that change with the change in the volume of the cost object.

The cost object is the items for which costs are being separately measured. These items could be products, services, product lines, etc.

For instance, a cloth used is a direct cost if you manufacture garments. Similarly, the wages paid to workers manufacturing garments form a part of direct expenses.

The following expenses are considered to be direct expenses:

• Opening Stock
• Purchases (less) Purchase returns
• Wages paid to workers
• Carriage/Freight Inwards
• Fuel/Water/Power/Gas
• Packaging materials and packaging charges

Indirect Expenses

Indirect expenses are expenses that are incurred to run the business as a whole. Such expenses cannot be directly assigned to a specific cost object.

Some of the indirect expenses include:

• Selling expenses like the commission of the sales agent, salaries of sales personnel, travelling expenses, warranty costs, etc.
• Administrative overheads
• Factory overheads like the supervisor’s salary, factory rent, utilities, supplies, depreciation, etc.
• Interest expense

How To Calculate Net Income?

Net Income is also known as net profit or net earnings. So let’s understand how net income is calculated using the net income formula.

Net Income Formula

As mentioned above, net income is the amount of revenue that remains after your business pays off all its expenses. This means net income can be defined as follows: 

Net income = total revenue – total expenses

To do this you will need to:

1. Find your total revenue, or gross income: Revenue minus cost of goods sold
2. Determine how much you earn before taxes: Subtract your business expenses, taxes, and operating costs from your gross income

Net income formula tips

When using the net income formula, it’s important to remember what total revenue and total expenses include:

• Total revenue can also be referred to as gross income, which is your revenue minus your cost of goods sold. 
• Your total expenses will include every cost you’re responsible for, including taxes, interest, debt, deductions, operating expenses, and general expenses.

To calculate a net profit margin, divide your net income by revenue and multiply it by 100 to get a percentage. This percentage will show you how much money you bring in from each dollar of revenue.

Net Income Calculation Example

Let’s say you run a small bakery and want to find your net income for the first quarter of the year. You crunch some numbers and create the following line items on your income statement:

• Total revenue: $75,000
• Cost of goods sold: $8,000
• Rent: $10,000
• Utilities: $2,000
• General expenses: $3,500
• Operating expenses: $4,500
• Payroll: $7,000
• Interest: $2,000
• Taxes: $6,000

Looking at these numbers, you have your total revenue on hand ($75,000). 

Next, you’ll need to calculate your total expenses, including the cost of goods sold, rent, utilities, general expenses, operating expenses, payroll, interest, and taxes. This will give you $43,000. Now you can plug both numbers into the net income formula:

Net income = total revenue ($75,000) – total expenses ($43,000)

Net income = $32,000

In the first quarter, your bakery had a net income of $32,000.

Where To Record Net Income

As mentioned above, the net income is the last item of your company’s income statement. The income statement is one of the three basic financial statements that represent the earning activities of your business.

It depicts the inflow of funds resulting from the sale of goods and services. Further, the income statement also depicts the outflow of funds in the form of resources used to generate sales.

Accordingly, your business’s income statement represents its profitability. That is, profits earned or losses incurred during a specific period of time. As net income is the last item on the income statement, it is therefore called the ‘Bottom Line.

Below is a sample income statement to help understand line items as well as the representation of net income or loss on the income statement.

Why is Net Income Important?

Net income gives you a better view of the financial health of your company since it represents the profit of the business after deducting expenses. 

For example, your business may show a large income at the end of a quarter, but until you bring in your expenses and see the full scope of your business spending, your financial view is incomplete. Net income is the other piece of the profitability puzzle, (the first is total income), one that companies and shareholders rely on for the most accurate information. 

Thus, you can understand the efficiency of your business operations by tracking its net income. E.g. Increasing net income gives you an understanding that you are efficient. However, falling net income indicates that you need to contain your operating and overhead costs.

It could be the case that a company’s revenues are increasing, but its operating costs are increasing at a rate higher than the increase in revenues.

Gross profit vs. net income?

Gross profit and net income should not be used interchangeably. Both gross income and net income can measure profitability, but net income provides the clearest picture. 

• Gross profit: Revenue minus the cost of goods sold. The cost of goods sold (COGS) is how much it costs to maintain production or perform a service. For example, materials and utilities are part of COGS. 
• Net income: Revenue minus all other expenses such as the cost of goods sold, taxes, admin expenses, and operating costs.

What is Operating Net Income?

Not to be confused with plain old net income, operating net income is certainly different. The biggest difference is how it expresses a company's profit. This portrayal can best be seen through their formulas.

Net income = total revenue - total expenses

Operating net income = total revenue - operating expenses

In other words, operating income is the excess revenue over operating expenses. That is, the amount of profit earned from the normal business operations after deducting operating expenses like Cost of Goods Sold, Depreciation, Office Supplies, Utilities, etc.

Thus, Operating Income helps to know how much income your business is able to generate from its core operations. That is, it does not include any expense or income not directly related to the core activities of your business. 

Net income alone factors in expenses such as taxes and administration. while operating income includes the expenses only from operations. These include selling, general, and administrative expenses.

Calculating net income for individuals 

Individuals can also calculate their net income to see how much money they take home after certain deductions. If you’re wondering how much money you actually make, start by finding your gross income. 

Your gross income is how much money you make before taxes and deductions, including taxable wages, tips, and income from interest and dividends. Then subtract taxes, payroll deductions, and other expenses from your gross income—this includes payroll taxes like Social Insurance, health care, retirement contributions, and legal expenses like loans, wage garnishments, and child support. The result is your net income.

Individual net income example 

Assume you earn a base salary of $50,000 spread across 24 paycheques. Each pay period, $430 goes toward income taxes, including Social Insurance, health, and health taxes, $45 goes toward health insurance, and $200 goes toward your pension. 

This means that each year, $10,320 goes toward taxes, $1,080 goes toward health insurance, and $4,800 goes toward your pension. This brings your total expenses to $16,200. Here’s your net income using the net income formula:

Net income = total revenue ($50,000) – total expenses ($16,200)

Net income = $33,800

Your net income for the year is $33,800, or $2,817 each month.

Net income calculations for your business

Net income shows a business’s profitability. There are many reasons why net income is important, such as determining how much profit can be divided among investors and how much money can go toward new projects. With the net income formula, you can easily calculate how profitable your business is by finding the difference between your total revenue and total expenses.

To better understand your company’s financial strength, you can invest in accounting software like QuickBooks Online. With QuickBooks Online, you can easily generate income statements to see how your net income is affecting your finances. By streamlining your financial reporting, you can get a better understanding of where you stand so you can continue to scale your business.

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