Net income, often referred to as “net profit,” “net earnings,” or simply “profit,” is a crucial metric that measures a company’s overall profitability. It’s the financial bottom line that indicates whether a business is making money or experiencing a net loss. Understanding How To Find Net Income is fundamental for any business owner, investor, or anyone interested in the financial health of a company.
In the world of finance, net income holds immense significance. It’s often the first number stakeholders look at after revenue to gauge a company’s financial performance. Think of the terms “in the red” or “in the black”—these old accounting terms, where losses were recorded in red ink and profits in black, directly relate to whether a business has a net loss or a net income.
Why Net Income is Crucial in Financial Analysis
While some small businesses might postpone calculating profitability until required by lenders or investors, consistently tracking your net income is a proactive and essential practice for monitoring your business’s financial well-being.
An increasing net income generally signals that your business is on a positive trajectory. Conversely, a stagnant or declining net income might indicate the need to reassess expenses and identify areas for cost reduction or revenue enhancement.
Net income is also a key figure for external stakeholders. Lenders use it to assess your ability to repay debts, ensuring you generate enough profit to cover loan obligations. Investors rely on net income to understand the potential for returns, evaluating how much profit is available for dividends, reinvestment, or reserves.
Let’s delve into the practical steps and formulas to calculate net income and gain a clearer picture of your business’s financial performance.
Calculating Net Income: The Formula Breakdown
Net income represents your company’s total earnings after all operating expenses, costs of goods sold, and other deductions are subtracted from total revenue. It’s essentially what remains after all the bills are paid. You might hear net income called net earnings, net profit, or the “bottom line”—a term derived from its position at the very bottom of the income statement. This figure represents the funds available for reinvestment, shareholder payouts, debt repayment, or future savings.
The standard formula for calculating net income is as follows:
Net Income = Revenue – Cost of Goods Sold (COGS) – Expenses
Breaking down this formula, the initial part, Revenue minus Cost of Goods Sold, actually calculates your gross income. Gross income is the profit earned directly from your core business activities, before considering operating expenses.
Therefore, the net income formula can also be expressed as:
Net Income = Gross Income – Expenses
For simplicity, it can be summarized even further:
Net Income = Total Revenues – Total Expenses
Net income can result in a positive or negative value. A positive net income arises when total revenues exceed total expenses, indicating profitability. Conversely, a negative net income, known as a net loss, occurs when total expenses outweigh total revenues, signifying that the business spent more than it earned during that period.
This formula can be applied to calculate net income for various periods—annually, quarterly, or monthly—depending on your business’s reporting needs and analysis frequency.
Net Income Formula in Action: An Example
Let’s illustrate the net income calculation with a practical example. Consider Wyatt’s Saddle Shop, aiming to determine its net income for the first quarter of 2023. Wyatt has gathered the following financial data:
- 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, Wyatt calculates his gross income by subtracting COGS from total revenues:
Gross Income = $60,000 (Total Revenues) – $20,000 (COGS) = $40,000
Next, Wyatt sums up all his operating expenses for the quarter:
Total Expenses = $6,000 (Rent) + $2,000 (Utilities) + $10,000 (Payroll) + $1,000 (Advertising) + $1,000 (Interest Expense) = $20,000
Finally, Wyatt calculates his net income by subtracting total expenses from his gross income:
Net Income = $40,000 (Gross Income) – $20,000 (Total Expenses) = $20,000
Therefore, Wyatt’s Saddle Shop’s net income for the first quarter of 2023 is $20,000.
Differentiating Net Income from Gross Income
It’s essential to distinguish between gross income and net income. Gross income, also known as gross profit or gross earnings, represents the revenue remaining after deducting the cost of goods sold (COGS). COGS encompasses the direct costs associated with producing goods or services.
The formula for gross income is:
Gross Income = Revenue – Cost of Goods Sold (COGS)
On an income statement, COGS is typically listed near the top, directly below revenues.
Common examples of costs included in COGS are:
- Raw materials used in production
- Direct labor costs
- Packaging, freight, and shipping expenses directly related to production
- Energy and utility costs for a production facility
- Depreciation of production equipment and machinery
It’s important to note that COGS does not include indirect expenses, also known as overhead, operating costs, or operating expenses. These encompass costs not directly tied to production, such as administrative salaries, rent, utilities for office spaces, insurance, and interest expenses.
The Relationship Between Net Income and Operating Income
Operating income provides another perspective on profitability, offering a more conservative view than gross income. It takes into account operating expenses, often categorized as Selling, General, and Administrative (SG&A) expenses. These are costs incurred in running the business that are not directly related to production. Operating expenses exclude non-operating costs like interest, taxes, amortization, and certain types of depreciation.
The formula for operating income is:
Operating Income = Gross Income – Operating Expenses
Gross income, operating income, and net income are interconnected metrics that progressively measure a company’s profitability with increasing levels of comprehensiveness.
By comparing the formulas, you can see how they differ and provide increasingly refined measures of profitability:
- Gross Profit: Revenue – COGS
- Operating Income: Revenue – COGS – Operating Expenses
- Net Income: Revenue – COGS – Operating Expenses – Non-Operating Expenses
The net income formula is the most comprehensive, as it incorporates all major expense categories: COGS, operating expenses, and non-operating expenses. This makes net income the most reliable and conservative measure of a company’s overall profitability.
Understanding the Operating Net Income Formula
Operating net income offers a view of a company’s profitability specifically from its core business operations, excluding income and expenses from non-core activities. These non-core items can include income tax, interest expense, interest income, and gains or losses from asset sales. Operating income is sometimes referred to as EBIT, or “Earnings Before Interest and Taxes.”
The formula for operating net income can be expressed as:
Operating Net Income = Net Income + Interest Expense + Taxes
Alternatively, it can be calculated as:
Operating Net Income = Gross Profit – Operating Expenses – Depreciation – Amortization
Investors and lenders often favor operating net income because it provides a clearer picture of a company’s profitability from its primary business activities.
For instance, a company might experience losses in its core operations. However, if it sells a significant asset, the gain from that sale could inflate the net income, making the company appear financially healthier than it truly is. Operating net income, by excluding such gains, offers a more accurate assessment of the company’s operational performance and valuation.
This distinction is crucial for understanding a company’s sustainable profitability, separate from one-time gains or losses.
Operating Net Income in Practice: An Example
Revisiting Wyatt’s Saddle Shop, let’s calculate his operating net income for the first quarter of 2023. To do this, Wyatt can add back the interest expense to his net income:
Operating Net Income = $20,000 (Net Income) + $1,000 (Interest Expense) = $21,000
Calculating both net income and operating net income becomes straightforward with organized bookkeeping. With proper bookkeeping practices, you’ll likely have an income statement (or profit and loss statement) readily available, which directly shows your net income. Income statements may even present operating net income as a separate line item before arriving at the final net income figure.
Net Income as a Key Item on the Income Statement
Net income holds a prominent position as one of the most critical line items on an income statement.
Business owners need to generate income statements, which are fundamental financial statements, alongside the balance sheet and cash flow statement. The income statement, also known as a profit and loss (P&L) statement, serves to detail how a company arrives at its net income. More importantly, it provides a comprehensive view of the money flowing into and out of the business over a specific period.
Here’s an example of an income statement, illustrating how net income appears at the bottom:
Coffee Roaster Enterprises Inc.
Income Statement
For Year Ended Dec. 31, 2023
| Category | Amount |
|---|---|
| Sales Revenue | $57,050.68 |
| Cost of Goods Sold (COGS) | $24,984.79 |
| Gross Profit | $32,065.89 |
| General Expenses | $11,049.55 |
| *Rent | $9,000.00 |
| *Bank & ATM Fee Expenses | $9.43 |
| *Equipment Expenses | $742.40 |
| *Marketing Expenses | $503.53 |
| *Merchant Fees Expenses | $794.19 |
| Operating Earnings | $21,016.34 |
| Interest Expense | $5,000.00 |
| Earnings Before Income Tax (EBIT) | $16,016.34 |
| Income Tax Expense | $10,000.00 |
| Net Profit | $6,016.34 |
Income statements, along with other financial statements, are compiled from your regularly maintained financial records.
By understanding how to find net income and interpreting income statements, business owners and stakeholders can gain valuable insights into a company’s financial health and make informed decisions.
