Net income is the amount that a person or business makes after deducting all the relevant expenses and taxes from the revenue that entity earns, according to Investor.gov. So, in addition to taxes, one would deduct the cost of goods sold (COGS), amortization and depreciation, interest charges and expenses (including sales or operating expenses, administrative expenses and general expenses).
You can easily find a business’s net income as the last line of a company’s income statement. It appears at the bottom of the income statement because it is derived after all the deductions have been made to show what a company made within a specified accounting period. In addition, you'll find the net income on the cash flow statement.
For an individual, your net income is what is left over after you account for your various paycheck deductions and pay your income taxes.
What Does Net Income Mean?
Net income represents a business owner's take-home pay after all the expenses have been deducted.
Does Net Income Mean Profit?
Net income is also known as net earnings or net profit, and it is a profitability metric. If you have money left over after all the expenses have been deducted, it means you have made a profit. On the other hand, if your net income is negative no matter how much revenue you generated, it indicates that your business is not profitable in the long run.
Gross vs. Net Income
As the IRS explains, gross income is the amount of money that an individual or company earns before deductions or taxes. It is also known as gross profit. For individuals, gross income includes wages, interest, capital gains, dividends, rents, profits, etc. from all sources.
On the other hand, gross income for businesses refers to all the revenues generated from sales of products or services before the deduction of taxes and any indirect expenses.
However, you shouldn’t confuse a company’s net income or net profit with gross profit. The latter refers to the amount left over after you only subtract COGS from the revenue you have generated. That amount usually includes the taxes and interest that have yet to be paid.
The formula for gross profit is:
Gross Profit = Revenue - COGS
Generally, COGS covers the direct costs of creating a product, delivering services to clients or acquiring goods for resale. So, it includes payments for raw materials, manufacturing or warehousing labor costs, equipment operation costs, inbound shipping, etc.
You can use the gross profit to determine how efficiently your business is generating profit from the sale of goods or services.
Types of Net Income
While net income is the bottom line, there are other deductions that can take place before arriving at the final value. These aspects of net income depend on what kind of expenses you deduct. They include:
Earnings Before Interest and Taxes (EBIT)
EBIT refers to the amount left over after deducting every operating cost from the sales revenue. However, that amount isn't reduced by the interest expense and income taxes that ultimately need paid.
The formula for EBIT is:
EBIT = Sales Revenue – Operating Expenses (COGS + Selling, General and Administrative expenses (SG&A))
You can also express it as:
EBIT = Net income + Taxes + Interest Expenses
Earnings Before Tax (EBT)
EBT is a way of measuring a company’s profitability or financial health. It is derived by deducting all operating and nonoperating expenses, such as COGS and interest expense from the sales revenue. However, it doesn’t deduct income taxes.
Another name for EBT is pretax income. As the Corporate Finance Institute details, its formula can be expressed as:
- EBT = EBIT - Interest Expense
- EBT = Net Income + Taxes
- EBT = Sales Revenues – (COGS + SG&A + Depreciation & Amortization)
Retained Earnings (RE)
Retained earnings refers to the net income a company keeps after distributing dividends to the shareholders. This income can be used to grow the business or pay off its debts.
The formula for RE is:
RE = Beginning RE + Net Income – Dividends
How to Calculate the Net Income Formula
You can calculate the net income of a business if you know the net income formula, which is:
Net income = Total Revenue – Total Expenses
And you can break it down further as:
Net Income = Sales Revenue – COGS – Interest Expenses – Other Expenses – Taxes
Net Income Calculation Example
Suppose Potty Inc. generated sales revenues worth $5.5 million in 2022. Also, suppose that the company incurred operating expenses worth $1.5 million and interest expenses worth $0.5 million. It paid $1 million as a tax expense.
In that case, you can calculate the company’s 2022 net income as follows:
Net income = $5.5 million – ($1.5 million + $0.5 million + $1 million) = $5.5 million - $3 million
Therefore, Potty Inc. had an income of $2.5 million in 2022.
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