Net income is the amount made by an individual or corporation after subtracting costs, allowances, and taxes.
In business, net income refers to the amount of money left over after all expenditures have been paid, such as salaries and wages, the cost of items or raw materials, and taxes. Net income refers to an individual’s “take-home” pay after taxes, health insurance, and retirement payments have been deducted. Net income should ideally be higher than expenditure to indicate financial health.
Did you know?
Net income is also colloquially called the ‘bottom line’, as it is the last line item that appears on an income statement.
Net Income Formula
Net income is the company’s entire profit after subtracting all business expenditures. Net income is also known as net earnings or net profit. It’s the money you have leftover to pay shareholders, invest in new projects or equipment, pay off debts, or save for the future.
The following is the formula for computing net income:
Net Income = Revenue – Cost of Goods Sold – Expenses
The first component of the procedure is likewise the gross income formula: revenue – the cost of goods sold.
In other words, the net income formula is as follows:
Net Income = Gross Income – Expenses
If you wish to keep things simple, you may write the net income formula as
Net income = Total Revenues – Total Expenses
It is possible to have a positive or negative net income. You have a positive net income when your company’s sales exceed its costs. If your total costs exceed your revenues, you have a negative net income, i.e., a net loss.
You can calculate your company’s net income using the method above: yearly, quarterly, or monthly, depending on your needs.
Also Read: What is the Difference Between Gross Profit & Net Profit?
Net Income Formula: An Example
Raj’s Chain Shop was looking for its first-quarter net profits in 2021.
The figures Raj is dealing with are
- Total revenues: ₹60,000.
- Cost of goods sold (COGS): ₹20,000,
- Rent: ₹6,000,
- Utilities: ₹2,000,
- Payroll: ₹10,000,
- Advertising: ₹1,000,
- Interest expense: ₹1,000.
First, Raj may compute his gross income by removing COGS from his total revenues:
₹60,000 – ₹20,000 = ₹40,000 in gross income.
Raj then totals his costs for the quarter.
6,000 + 2,000 + 10,000 + 1,000 + 1,000 = ₹20,000 in expenses
Raj may now compute his net income by subtracting his gross revenue from his expenses:
₹40,000 – ₹20,000 = ₹20,000 in net income
Raj had a net income of ₹20,000 for the quarter.
Operating Net Income Formula
Operating net income is another essential net income metric to keep track of. Net income is equivalent to operating net income. However, it only considers a company’s earnings from operations, not revenue and costs unrelated to its primary activities. Income tax, interest expenditure, interest income, and profits or losses from the sale of fixed assets are all examples.
EBIT, or “earnings before interest and taxes,” is another term for operating income.
The formula for calculating operating net income is
Operating Net Income = Net Income Interest Expense Taxes
In other words, operating net income can be calculated as follows:
Operating income = Gross Profit – Operating Expenses – Depreciation – Amortisation
Investors and lenders sometimes prefer operating net income over net income. It allows them to understand better how profitable the company’s critical business operations are.
For example, a company’s fundamental activities may be losing money. The gain on the sale of an expensive piece of machinery, on the other hand, will be included in the company’s net income. That increase may give the impression that the business is doing well while battling to stay afloat. Operating net income excludes the gain, giving financial statement users a more accurate view of the company’s profitability and value.
A cash flow statement can provide you with this information.
Operating Net Income: An Example
Let’s go back to Raj’s Chain Shop. Raj could add the interest expenditure to his net income to determine his operating net income for the first quarter of 2021.
Operational Net Income (₹21,000) = Net Income (₹20,000) + Interest Charge (₹1,000)
Calculating net income and operating net income is simple if a business maintains solid records. You already have a profit and loss or income statement indicating your net income in such instances. Before adding additional income and costs to get at net income, your company’s income statement may even split out operating net income as a specific line item.
Net Income and Net Profit
|
Net Income |
Net Profit |
|
|
Definition |
Net income is the amount of money left over after all costs that have been eliminated. |
The profitability of a company is measured by its net profit. Expenses are removed from income to obtain a net profit for each spending. |
|
What does it indicate? |
During an accounting period, it displays the entire cash intake of income minus costs. |
It depicts the company’s monetary profitability. |
|
Types |
Earned and unearned. |
Gross profit or net profit. |
|
Dependency |
Revenue and profit are essential. |
Only reliant on revenue. |
|
Uses |
Allows you to compute total real earnings and provide investors with the ability to examine your company’s income and costs. |
Allows you to determine a company’s profitability and tax liabilities for a specific period. |
What Is the Importance of Net Income?
Net income is a particular unit for assessing a company’s overall profitability and health.
Small business owners must track their net profits carefully to better understand their net profit margin and identify how they may increase sales. Some business owners anticipate operating at a loss, particularly in the early stages of their venture. Determining net income allows them to know precisely how significant a net loss they anticipate and how long they expect to maintain losses.
Changes in net income can impact a range of financial decisions, such as how much you put into a savings account and organise your retirement plan.
Also Read: What are Retained Earnings?
Net Income Analysis
Net income is a highly valuable indicator for many parties when making crucial choices in a firm. It can be calculated without the aid of a calculator.
In most circumstances, a more significant net income is preferable to a lower net income. When opposed to a low net income, a high net income may be deemed harmful due to the higher amount of tax. Many massive corporations (such as Amazon) reinvest earnings back into the business. They minimise their net income to pay less in taxes.
A more significant net income will benefit a firm seeking funding with a loan application since creditors sometimes have loan agreements that need a particular profit level each year. It might be an issue for management since they want to show less profit to save money on taxes, but they also want to fulfil the lender’s standards.
In practice, what does this mean? Earnings and net profit can be altered in accounting to meet the firm’s needs. Specific revenue recognition standards can record revenue in a company’s books before the money has been generated. It enables management to fulfil the criteria of both the tax authorities and the lender.
The corporate financial statement’s footnotes will clarify the metrics used and determine net income.
Conclusion
Net income is the differential between a company’s earnings and its business and operational expenditures. Net income is calculated by deducting all relevant deductions and taxes paid from total income. Net income enables you to determine how lucrative your company is. It can assist you to examine a company’s stock if you’re an investor. It can also help you grasp your actual take-home salary as an individual.
Follow Legal Tree for the latest updates, news blogs, and articles related to micro, small and medium businesses (MSMEs), business tips, income tax, GST, salary, and accounting.