Calculating Net Income: What You Need To Know

Accounting
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Fincent Team

The growth of any business is primarily dependent on incoming revenue. However, to get the most accurate financial picture of your business, you must also know whether your company is profiting after deducting business expenses. And for that, you need to determine your business’s net income.

Calculating your business’s net income helps you assess your business’ profitability, plan budgets, decide whether to expand or reduce operations and relay information to investors.

We explore what you need to know about the net income calculator, why it matters for your business, and when you should look at it.

What Is Net Income?

The net income refers to the company’s total profits after deducting business expenses. It is also referred to as net profit, net earnings, or the company’s bottom line.

Net income can either be positive - if you have more revenues than expenses or negative - if your expenses outweigh your revenues. (also known as a net loss).

Net income vs. Gross Income

Gross income plays an important role in determining a company’s net income. However, it is important to know the differences between the two to understand their role and significance in financial statements.

Gross income typically defines the total earnings of a business entity before expenses such as taxes and deductions are accounted for. On the contrary, net income refers to the earnings business generates after these deductions have been subtracted from the total income.

A business' net income calculation helps project a robust financial image and enhances its market valuation to a significant extent. This is why business entities should devise measures to increase their net income and look for different ways to boost their operating income sustainably.

How Can You Calculate Net Income?

You can calculate net income by subtracting the cost of goods sold and expenses from the business’s total revenue.

Before calculating net income, let us understand the gross income formula:

Gross Income = Revenue – Cost of Goods Sold

Now, let us have a look at the net income formula:

Net Income = Gross Income – Expenses

Alternatively, you can use the formula below to calculate net income:

Net Income = Revenue – Cost of Goods Sold – Expenses

Revenue here means the actual amount of money a business takes in over a given period. This can include credit cards, cash, checks, and any other way someone customers pay for its products or services.

Expenses, on the contrary, are anything that your business pays out to employees, vendors, the government, etc. This can include various generic costs such as rent, lease, taxes, salaries, and other more obscure expenses.

Net Income vs. Net Profit

Net income is often referred to as net profit or the bottom line. While net income and net profit mean the same thing, the catch here is that there are many kinds of profit, but only your net profit equals your income.

So, although net income equals net profit, net income doesn’t equal profit, in general. And to communicate clearly with other business people, it is always best to specify the kind of profit you’re referring to.

Where Can You Record Your Business' Net Income?

You need to record net income on your business’s income statement - one of three main financial statements companies use.

An income statement shows you your company's profitability and reports your business’s profits and losses over a specific period. Income statements also show the process of determining net income.

Total revenues, gross income, expenses, cost of goods sold, taxes, and net income are all line items on the income statement. The net income is the final line of the statement, which is the reason why it is also called the bottom line.

Example of Net Income Calculation

Here is an example of how you can calculate your company's net income for a given month.

Here are the stats:

  • Total revenues: $50,000
  • Cost of goods sold: $20,000
  • Expenses:
    Rent: $5,000
    Utilities: $1000
    Purchases: $3,000
    Payroll: $10,000
    Taxes: $1000

Firstly, you would need to find your business’s gross income by subtracting the cost of goods sold from your total revenue.

Gross Income = $50,000 – $20,000

Gross Income = $30,000

In the next step, youneed to tally up total expenses for the month (not including the cost of goodssold). After adding utility, rent, purchase, payroll, and tax expenses, yourexpenses total $20,000. Now, subtract your total expenses from your grossincome to calculate your net income.

Net Income = $30,000 –$20,000

Net Income = $10,000

Your net income for theperiod is $10,000

Operating Net Income

One of the other useful net income numbers to track is operating net income. Although similar to net income, operating net income looks at a business's profits from operations alone; it doesn't consider income and expenses that aren’t related to the business' core activities.

This includes interest expense, interest income, income tax, and gains or losses from sales of fixed cost assets.

Sometimes referred to as EBIT, or earnings before interest and taxes, the formula for operating net income is:

Operating Net Income = Net Income + Interest Expense + Taxes

Alternatively, you can calculate operating net income through the formula below:

Operating Net Income = Gross Profit – Operating Expenses – Depreciation – Amortization

In some cases, investors and lenders prefer to look at operating net income rather than net income. This gives them a better idea of how profitable the company’s core business activities are.

For instance, a business might be making a loss and losing money on its core operations. However, if it opts to sell a valuable piece of machinery, the gain from the sale will be included in the company’s net income. This gain might make it seem like the company is doing fine, when in fact, they’re struggling to stay afloat.  

Operating net income, on the contrary, takes the gain out of consideration, so users of the financial statements get a clearer idea of the company’s profitability.

Why Does Net Income Matter?

A large part of any business's success depends on how much the business makes from sales of services offered. Apart from this, you also have to consider what you’re paying to keep the business going.

The net income can help you understand the actual cost of running your company.

Given below are some other pointers which highlight the significance of net income:

  • Net income helps business owners and other stakeholders assess if the business is making enough money or not. Additionally, it also allows them to assess the business' profitability and sustainability.
  • Net income allows the management of a business and other lending institutions to estimate if they will be able to pay off their existing financial loans/dues or not.
  • A high net income indicates the financial viability of a company and projects a healthy business image.

When Should You Be Looking At Net Income?

Now that we know what net income is and the formula to calculate it let's discuss what it is used for and when you should consider it.

Profitability

Net income is typically used to determine a company’s profitability. By measuring this number regularly (quarterly, yearly), investors and stakeholders can determine how quickly the business is growing, whether or not it is profitable, and then use those numbers to make projections for future growth, revenues, and goals.

Earnings per Share

The net income formula is also used by businesses to calculate their earnings per share. Earnings per share is essentially the part of a business' profits devoted to each share of common stock and is an indicator of a company’s profitability.

This is determined by taking the net income, subtracting the dividends on preferred stock, and dividing the same by the average outstanding shares.

For Investors and Creditors

The net income formula can also be helpful for investors and creditors to understand how efficiently companies make money. This can help them evaluate and determine whether or not it’s a good idea to invest or loan money, how much they should invest and/or loan, and how long the business will take to pay back loans or turn more profits.

In short, net income is the perfect calculation to determine the business estimations and make projections for the future.

To Wrap Up

Net income gives you an idea of how your business is performing in terms of profitability. It is essential to know this number so you can show shareholders you're growing, reach out to investors, and secure a good line of credit when needed.

A good net income calculator can help you automatically calculate this number if you do your due diligence and accurately enter in all your earnings and expenses. This will help you understand better on bad debt expenses customer did not pay the amount owed.

However, this can be quite a challenging task, and if you want to focus solely on growing your business, you can outsource all your bookkeeping needs to the industry-leading team at Fincent.

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