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written by | April 28, 2022

Guide to Calculating Net Income - Formula and Examples

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Table of Content


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 Khatabook for the latest updates, news blogs, and articles related to micro, small and medium businesses (MSMEs), business tips, income tax, GST, salary, and accounting.

FAQs

Q: What are the consequences of a business's significant or low net income?

Ans:

A sizeable net income indicates that a firm is successful and can repay its obligations, pay dividends to shareholders, and may be able to expand. A low net income would imply the inverse.

Q: What is the formula for calculating net income?

Ans:

Net income is determined by deducting a company's entire costs from its total revenue.

The formula is as follows:

Total Revenue – Total Expenses = Net Income.

Q: What is the significance of net income?

Ans:

Net income is significant since it represents a company's profitability. It is used to judge if a firm is profitable or not. It may also be used to decide whether to borrow money or recruit new investors.

Q: What is the difference between revenue and net income?

Ans:

Revenue is an amount that a firm receives during the year. It includes discounts and deductions. It is called gross income, in which costs are minus to determine net income. Net income is the total earnings or profit of the firm, and it is calculated by considering revenues and adjusting all expenses.

Q: Why is net income added to liabilities on the balance sheet?

Ans:

Net income is added to penalties because net income is the gap between the value of output and cost (finance production). Outputs of the company are assets, and the cost is a liability. It creates a gap as the liability side is lower than the asset side; net income is added on the liabilities side to fill this gap.

Disclaimer :
The information, product and services provided on this website are provided on an “as is” and “as available” basis without any warranty or representation, express or implied. Khatabook Blogs are meant purely for educational discussion of financial products and services. Khatabook does not make a guarantee that the service will meet your requirements, or that it will be uninterrupted, timely and secure, and that errors, if any, will be corrected. The material and information contained herein is for general information purposes only. Consult a professional before relying on the information to make any legal, financial or business decisions. Use this information strictly at your own risk. Khatabook will not be liable for any false, inaccurate or incomplete information present on the website. Although every effort is made to ensure that the information contained in this website is updated, relevant and accurate, Khatabook makes no guarantees about the completeness, reliability, accuracy, suitability or availability with respect to the website or the information, product, services or related graphics contained on the website for any purpose. Khatabook will not be liable for the website being temporarily unavailable, due to any technical issues or otherwise, beyond its control and for any loss or damage suffered as a result of the use of or access to, or inability to use or access to this website whatsoever.
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Disclaimer :
The information, product and services provided on this website are provided on an “as is” and “as available” basis without any warranty or representation, express or implied. Khatabook Blogs are meant purely for educational discussion of financial products and services. Khatabook does not make a guarantee that the service will meet your requirements, or that it will be uninterrupted, timely and secure, and that errors, if any, will be corrected. The material and information contained herein is for general information purposes only. Consult a professional before relying on the information to make any legal, financial or business decisions. Use this information strictly at your own risk. Khatabook will not be liable for any false, inaccurate or incomplete information present on the website. Although every effort is made to ensure that the information contained in this website is updated, relevant and accurate, Khatabook makes no guarantees about the completeness, reliability, accuracy, suitability or availability with respect to the website or the information, product, services or related graphics contained on the website for any purpose. Khatabook will not be liable for the website being temporarily unavailable, due to any technical issues or otherwise, beyond its control and for any loss or damage suffered as a result of the use of or access to, or inability to use or access to this website whatsoever.