What is the net income formula:
The net income formula is a company’s profit after business expenses are accounted for. It’s total revenue minus total expenses.
Bringing in revenue should be one of your top priorities as a small business owner. However, to fully understand the profitability of your business, you need to know how to calculate your net income.
To help you get started, we’ve created this net income formula guide that you can use to calculate your profitability. Below, we’ll define net income, explore how to calculate it, and delve into why it's a necessary metric for understanding your business's financial health.
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Net income is the amount of money your business actually keeps after covering all its expenses.
Here’s the basic net income formula:
Net income = Total revenue – total expenses
Your total revenue is all the income your business brings in through sales, services, or other income sources. Total expenses include everything from rent and utilities to payroll, taxes, loan interest, and even depreciation on equipment.
Once you subtract all of your business expenses from your revenue, what’s left is your net income. If the number is positive, you’re making a profit. If it’s negative, your business is operating at a loss, and it may be time to revisit your spending, pricing, or revenue strategy.
Net income is one of the most important indicators of your business’s financial health. Investors, lenders, and even potential partners typically look at your net income to understand how well your business is performing. It also plays an important role in tax reporting and can influence how much you owe the IRS.
Net income might be the official term, but you’ll often hear it called by a few other names, depending on the context. Some of the most common include:
In business, net income, net profit, and bottom line are typically used interchangeably. On financial statements, you might also see it labeled as net earnings. Regardless of the name, it all refers to the same thing: the amount of money left over after all expenses are deducted from your total revenue.
For individuals, especially on pay stubs, net income is usually called take-home pay—what you actually receive after taxes, insurance, and other deductions.
Net income gives you a better view of your company’s performance since it represents the business's profit after deducting expenses.
A positive net income signifies profitability, demonstrating your ability to generate revenue that exceeds your expenses. Conversely, a negative net income indicates a net loss, prompting you to investigate areas for improvement.
For example, your business may show a large income at the end of a quarter, but your financial view is complete once you bring in your expenses and see the full scope of your business spending. 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.
By tracking your expenses and net income over time, you can monitor your financial progress and identify potential issues.
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. Distinguishing between gross profit and net income is crucial for business owners because it provides a more clear view of your company's financial health.
Understanding both gross profit margin and net income margin can significantly impact your business decisions. Gross profit margin helps you assess your pricing strategy and production efficiency. Net income, on the other hand, reflects your overall profitability, guiding investment and growth decisions for your company.
Net income (NI) is used to assess your company's profitability. It resides at the bottom of your income statement, reflecting the profit remaining after subtracting all expenses from your total sales revenue.
To calculate net profit, you’ll use the following net income formula:
Net income = Total revenue - Total expenses
Here’s a step-by-step guide on how to calculate net income
Add up all the money your business earned during the period. This includes sales, services, and any other income streams.
COGS are the direct costs tied to producing goods or services (like materials, manufacturing, or shipping).
Deduct day-to-day business expenses like rent, utilities, payroll, marketing, and administrative costs from your gross profit.
Include non-operational expenses such as:
After subtracting all expenses, the remaining amount is your net income, which reflects your business’s profitability.
This step is optional, but if you want to assess your profitability as a percentage, you can do so by following this formula:
When calculating your net income, the expenses you’ll deduct include:
By factoring in all these expenses, net income provides a clear and concise picture of your company's financial health and profitability. It's the foundation for calculating earnings per share (EPS), a metric that shows how much profit is allocated to each outstanding share of stock.
This net income formula applies to both businesses and individuals, but the specific expenses factored in will differ.
Let's say you run a bakery, and your monthly revenue is $10,000.
Here's a breakdown of your potential expenses:
So, here’s how you’d calculate your bakery’s net income:
$10,000 (Total revenue)
- $4,000 (COGS)
- $3,000 (Operating expenses)
- $500 (Interest expense)
- $750 (Taxes)
Net income = $1,750
This example shows that after covering all your business expenses, your bakery has a net income of $1,750 for the month.
For an individual, calculating net income differs from business. Let's say your gross salary is $5,000 per month.
Here's a breakdown of possible deductions:
Following the formula but considering deductions instead of expenses:
$5,000 (Gross salary)
- $1,000 (Federal income tax)
- $750 (Social Security and Medicare)
- $200 (Health insurance)
Net income = $3,050
This example shows your net income, or take-home pay, is $3,050 after accounting for deductions.
To stay compliant and avoid IRS fines, you’ll need to report your net income correctly. The form you’ll use depends on your business structure:
Accurate bookkeeping is key to calculating your net income and preparing your tax returns. Be sure to keep detailed records of your income, expenses, and supporting documentation throughout the year.
When using the net income formula, make sure you keep these tips in mind:
Total revenue refers to the entire amount of income your business earns from its core operations. This includes sales of products or services, interest income, rental income, or any other business-related earnings.
It’s important not to confuse this term with gross profit, which is total revenue minus the cost of goods sold (COGS).
For example, if you bring in $500,000 in sales and it costs $200,000 to produce your goods (COGS), your gross income is $300,000, but your total revenue stays at $500,000.
Your total expenses encompass every cost associated with running your business, including:
Forgetting any of these can throw off your net income, which might leave you with an unrealistic view of your business’s profits and could impact your tax reporting.
Once you’ve got your net income, you can take it a step further and calculate your net profit margin. This shows what percentage of your revenue turns into profit, and you can do this by dividing your net income by revenue and multiplying it by 100 to get a percentage.
For example, if your net income is $50,000 and your total revenue is $200,000, your net profit margin is 25%. That means for every dollar you earn, you’re keeping 25 cents as profit.
Your business’s financial health isn’t something you figure out once and forget—it changes over time. That’s why it’s important to regularly review your income statements and see how your net income is trending.
Are profits growing? Are expenses creeping up?
Check in consistently so you can spot patterns, catch potential issues early, and adjust your strategy before small problems become big ones.
The income statement is the primary financial document for finding a business’s net income. If you’d like to review the figures that determined your net income, simply read the income statement from top to bottom.
Income statements show how profitable your company is, with profits and losses recorded over a given period—while the other two main financial statements where net income is recorded (balance sheets and cash flow statements) serve different purposes.
The beauty behind financial statements is that they all tie back to one another. And a common denominator of these statements is net income.
Here’s the breakdown of the connection:
Understanding these connections between financial statements empowers you to gain a more comprehensive view of your company's financial health. Net income isn't just a single figure; it's a vital piece of the puzzle, providing valuable insights into your profitability and its impact on your overall financial picture.
Net income gives you a clear picture of your business’s profitability, but only if you calculate it correctly. It’s surprisingly easy to make small mistakes that can throw off the numbers—and possibly your taxes. Here’s how to avoid the most common ones:
1. Not separating personal and business expenses
Mixing personal and business finances can make your records messy and throw off your net income calculations. Always use a dedicated business bank account and credit card to keep things clean and clear. The IRS also recommends this practice to simplify audits and ensure accurate tax reporting.
2. Forgetting to include all expenses
It’s easy to overlook certain deductions like depreciation, interest, or small recurring expenses, but they can add up. Leaving them out means you’ll overstate your net income, which could lead to paying more in taxes than necessary. Be sure to track all deductible business costs throughout the year.
3. Confusing gross income with net income
Gross income is what you bring in before expenses, while net income is what’s left after expenses. Mixing the two can lead to poor financial decisions or inaccurate forecasting. Using bookkeeping software can help separate and track these numbers more accurately.
4. Not updating records regularly
Waiting until the end of the quarter or year to reconcile your books can lead to errors or missed deductions. Keep your recordkeeping timely and consistent, so you always have an accurate picture of your financials, which makes calculating net income much easier.
5. Using the wrong formula
Net income = Total revenue - total expenses.
Some business owners accidentally use operating income instead, which doesn’t account for factors like taxes, interest, or one-time costs. Double-check that you're including all expenses, not just the day-to-day ones.
Accounting software empowers you to take your bookkeeping to the next level. Tools like QuickBooks can significantly improve efficiency, saving valuable time and resources. Consider exploring these solutions to unlock a smoother and more efficient experience when managing your business finances.
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