The Net Income Formula Explained

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Net income is the total income your business makes after all expenses are subtracted. As a small business owner, this information helps gauge how much money your business is actually making.

Additionally, net income helps lenders, investors and potential buyers gain insight into the business’s financial health, influencing their decisions to support or engage with the business.

This blog post will guide you through the net income formula — how to calculate it, why it’s important and where you can find it on financial statements.

How to Calculate Net Income

To calculate net income, subtract your business’s total expenses from total revenue. The net income formula allows you to gauge the efficiency of business operations and the company’s ability to generate profit.

Net Income = Total Revenue – Total Expenses

For a more detailed version of the net income formula, you can break down exactly what factors into those expenses.

Net Income = Revenue – Cost of Goods Sold – Expenses – Tax – Interest on Debt

What Goes Into the Net Income Formula?

Revenue. Also referred to as net sales, revenue is the total income your business makes from selling products and services during a given period. Additionally, your company may have revenue from sources other than selling your product (referred to as non-operating revenue). Non-operating revenue can include interest income, dividend income and income from selling assets or equipment.

Cost of goods sold (COGS). As its name suggests, the cost of goods sold is how much money it takes to produce and sell your product. Costs included in this category are raw materials, wages for workers on the production line, utilities for the production facility, equipment, repairs and maintenance, and shipping.

Expenses. This term sounds very general, but in this instance, expenses are costs that are not directly related to producing goods. These business expenses include advertising and marketing, employee training and benefits, insurance, office leases, and legal fees. Some of these expenses may be tax-deductible.

Tax. This can vary depending on your location and business structure, but the types of business taxes included in this category are income tax (on taxable income), estimated taxes, employment and self-employment taxes, and excise taxes.

Interest on debt. If your company has any outstanding interest on loans, bonds or business credit cards, it needs to be factored into your net income calculation as interest expenses.

What Is Net Income?

Net income is the amount of money left over after deducting all taxes, depreciations, interest and expenses during a given period. It’s also referred to as net profit, net earnings or the bottom line. A company’s net income represents its profitability after accounting for all operations costs. It provides a clear picture of how efficiently a company is managing its resources to generate profits.

Positive net income indicates that the company is profitable and has managed to generate excess funds after covering all its costs. This is generally considered a favorable sign for the company’s financial health and performance.

A negative net income indicates that the company is not currently profitable and is incurring more expenses than it is generating in revenue. This situation is often referred to as a net loss or operating at a loss. This can be a concerning sign for the company’s financial health and sustainability, as it may suggest difficulties in generating enough income to cover its operations and obligations.

You can also use net income for personal finances. A personal net income is your gross income minus taxes and other deductions.

What Is the Difference Between Net Income and Net Profit?

The terms “net income” and “net profit” essentially mean the same thing. Both terms refer to the final profit figure a company generates after all expenses have been subtracted from total revenue.

What Is the Difference Between Net Income and Gross Income?

Gross income, or gross profit, is a company’s earnings after the cost of goods sold (COGS) is deducted.

Gross Income = Total Revenue – Total Cost of Goods Sold

What Is the Difference Between Net Income and Operating Income?

Operating income is a company’s earnings after operating expenses are deducted. Operating expenses, also called operating costs, are costs associated with keeping the business running. These include administrative expenses such as utility bills, property taxes, office supplies and payroll.

Operating Income = Gross Income – Operating Expenses

Operating income is the profit a company generates from its core business activities. It gives a clear picture of how well the company is performing in its primary operations.

In contrast, net income accounts for all financial obligations, making it a more comprehensive indicator of a company’s financial health.

Why Is Understanding Net Income Important?

Net income is an important metric for assessing a company’s profitability and valuation. The net income formula provides valuable insights for investors, business owners, lenders and analysts alike.

Investors. Investors rely on net income figures to assess a company’s financial health and its ability to generate returns. A consistent and growing net income indicates a profitable and stable enterprise.

Business owners. For business owners, net income is an indicator of the effectiveness of their business strategies. It helps in evaluating the success of cost management and revenue generation.

Lenders and creditors. Lenders may use net income as a measure of a company’s ability to service its debt. A higher net income often implies a better ability to repay loans.

Analysts. Financial analysts use net income as a basis for various financial ratios and metrics that provide deeper insights into a company’s performance.

Where Can I Find Net Income on a Balance Sheet?

The net income figure is not directly found on a company’s balance sheet, but at the bottom of the income statement, also known as a profit and loss statement. This is why it’s commonly referred to as a company’s “bottom line” number. A company’s income statement summarizes its revenues, expenses and net income over a specific period.

You can also find net income at the beginning of a company’s cash flow statement.

DISCLAIMER: This content is for educational and informational purposes only, and is not intended as financial, investment, or legal advice. The information herein may contain errors or inaccuracies, and we make no representations or warranties as to its reliability, accuracy, or applicability to your personal situation.