How to Calculate Net Income (Formula and Examples)
Every business run to make a revenue needs to determine its annual net income to conclude on its profit or loss margin for each year.
Isn't a company's income revenue enough to determine its profit or loss margin? A company's income revenue will show how much or less a business is generating from offering its services but doesn't necessarily determine the most accurate financial condition.
As a business owner, you must understand that your business's success doesn't depend solely on how much you are generating from sales and services. No company is run with pieces of paper or in an empty room with no equipment and employees. Expenses cannot be ruled out when trying to determine what profit a company has made.
Net income does more than helping you as a business owner determine your profit or loss margin. It can also help you paint a vivid picture of the actual cost of running your business and how well your business is being managed.
This post will walk you through what net income is and how to calculate net income like an expert business accountant in a few steps. Just make sure you stick to the end of the guide!
What is Net Income?
Net income, net earnings, net profit, or a company's bottom line mean the same thing. Net income is a crucial metric that shows a business's actual take-home pay after all expenses have been deducted from its income revenue.
Every business has its operating expenses, i.e., the cost of keeping the company up and running. Depending on individual companies, these expenses often include; payroll costs, operating expenses, taxes, rent utilities, depreciation, wages, etc.
The net income or the company's bottom line can either be negative or positive. If your business' revenue is greater than expenses, you'll probably end your account with a positive net income.
In contrast, if expenses are greater than your total income revenue, then your business would end up with a negative net income.
What is the Difference Between Positive and Negative Net Profit?
Positive net income means that your business has enough savings for the rainy days, i.e., you have enough leftovers to invest in new projects and equipment, distribute to shareholders, pay off debts, and so on.
Negative net income, which is often referred to as net loss, means that the business has no leftover after deducted expenses. This means debt! and often, companies with so much net loss may not have enough to pay off debts, pay employees and shareholders or continue to run.
What is the Difference Between Net Income and Gross Profit?
Net profit and gross profit are two of the essential profitability metrics for any business. These two concepts can be easily misunderstood by people who are new to finance and accounting topics. Here is a breakdown of the two concepts in a few bullet points;
- After subtracting the costs of producing and distributing its products, the profits a company earns are called the company's gross profit.
- The company's gross profit assesses a company's ability to make a profit while concurrently managing its production and labor costs.
- Net income shows a company's profit after all of its expenses have been paid from income revenues.
- Net income covers a lot more information than what profit a business makes. It also provides valuable insight into how well the management team runs all aspects of the business.
Why is it Important to Know How to Calculate Net Income?
As a business owner, you are just one of the many people to whom your company's net profit is vital. Investors and creditors are also keen on knowing your company's net profit. Your business' net income is a good indicator that shows investors what your company's financial stand point is and your ability to manage and control assets efficiently.
A company's net profit will determine if it can pay dividends to investors and keep them investing even more. A positive net income will also help creditors conclude the company's financial ability and how well they can pay off debts from its successful running.
Lastly, the company knows how much to keep, and the management is informed about how well the company can pay salaries and bonuses.
How Do I Calculate My Business' Net Income?
Calculating your business' net income can be done using a simple and easy-to-understand formula. To make the calculation a lot easier, this section will cover the two most used formulas.
Formula 1: Net income = Total Revenues – Total expenses
If you are using this formula, then all expenses must have been summed up. i.e., cost of goods sold, interest and taxes, operating expenses, etc.
An example using formula:
Josh runs an in-house database company where he manages data and security for different finance companies that require strict compliance with federal rules. Josh was able to generate a large amount of revenue while keeping his expenses relatively low.
Josh's needs to calculate his income profit for the year, and here is a breakdown of his income statement.
- Revenues $500,000
- Computer expenses $50,000
- Salaries $100,000
- Utilities $5,000
- Taxes $5,500
From this income statement, Josh’s expenses will be $50,000 + $100,000 + $5,000 + $5,500 = $160,500.
Using formula 1; Josh’s Net Income = Total revenue – Total expenses; i.e. $500,000-$160,500 = $339,500
Formula 2: Net income = Revenues – Cost of goods sold – expenses
For example; A company has the following income statement and wants to calculate the net income for April.
- Total revenues: $50,000
- Cost of goods sold: $15,000
- Rent: $5,000
- Utilities: $500
- Purchases: $1,000
- Payroll: $5,000
- Taxes: $1000
From the above income statement, the total expenses = $5,000 + $500 + $1,000 + $5,000 + $1,000 = $12,500.
Net income = Total Revenue – Cost of goods sold – Expenses.
$50,000 - $15,000 - $12,500 = $23,000.
The net income of this company for April is $23,000.
Wrapping it Up
Every business needs a positive net income to reinvest in new projects and equipment, pay shareholders, eliminate debt, and keep the company afloat.
A company's net income will also determine its tax rate. You can get more information on net profit and tax calculation from the Internal Revenue Service (IRS) official website.
If you are running a large business with high-level operations and a constant increase in revenue, learning how to calculate net income in your company may look daunting. This is where professional accounting solution service providers like ZarMoney Accounting come in.
It is good to know how to calculate your business's net income, but you don't have to do it yourself. You can save yourself the stress and possibilities of making errors that may be costly to your business’ growth by outsourcing your business' accounting needs to reputable service providers.
With ZarMoney Accounting, you can manage your invoices, pay bills, access your inventory, compile net income statements, calculate net income and even remit your tax and deductions to the appropriate agencies.