Understanding the financial health of your business is vital. And there are multipleimportant metrics you should track that can offer valuable insight. But perhaps the mostimportant is net income, which indicates whether your company has made a profit. But it’smore complicated to calculate than just looking at your bank account balance.
What Is Net Income?
Net income, often referred to as the “bottom line” because it appears at the bottom, or end,of an income statement,reflects whether a business has made a profit after all expenses are deducted from totalrevenue. It’s profit that can be distributed to business owners or reinvested back into thebusiness. Investors and lenders use net income to help decide whether a company is worthy ofinvestment or a loan. Publicly traded companies use it to calculate earnings per share anddistribution of dividends.
Key Takeaways
- Net income, also known as the bottom line, indicates a business’s profitability. Itshows how much profit is left from revenue after accounting for expenses.
- Net income is profit that can be distributed to business owners or shareholders orinvested in business growth.
- Investors and banks consider net income when deciding whether to invest in or lendmoney to a business.
- Business accounting software helps you track financial metrics, including net income.
Net Income for Businesses Explained
Net income is the amount of profit a business has left over after it pays all its expensesover a specified period, such as a fiscal year or quarter. These expenses include the costof producing goods, operating expenses,non-operating expenses and taxes—all of which are subtracted from a company’s total revenueto arrive at net income.
Some small businesses start tracking expenses and revenue with a simple spreadsheet—but evensmall businesses and startups can benefit from businessaccounting software.
Other Names for Net Income
Net income is also referred to as net profit, net earnings, net income after taxes (NIAT) andthe bottom line—because it appears at the bottom of the income statement. A negative netincome—when expenses exceed revenue—is called a net loss.
Net profit
Net income and net profit are often used interchangeably. However, profit refers to what thatremains after expenses and can be used in other calculations. For example, gross profit is revenueminus the cost of goods sold (COGS). So be sure to pay attention to the type of profitreferenced (net profit, gross profit, etc.) to make sure that you’re using net profit as thecorrect synonym for net income.
Net earnings
Another way to reference net income. Earnings are your company’s profits after expenses andliabilities, including taxes.
Importance of Net Income for Businesses
Net income is also used to calculate other metrics such as net profit margin and operatingcash flow. Banks consider net income when approving a business loan application, as doinvestors when deciding whether to invest in a company. Companies use net income tocalculate earnings per share (EPS), a widely used profitability metric, to report toshareholders, VCs and other investors.
Net income is also used to calculate net profit margin, which is net income expressed as apercentage of revenue. This shows how much of revenue is converted to actual profit afterexpenses are paid. More efficient companies have higher percentages or margins. But thiswill vary by industry.
Business accounting software makes it easier for you to generate reports and get access toreal-time data. And managerial accountingpractices can take that data a step further. Make better and more strategic businessdecisions as your company sees new challenges or opportunities for growth.
Net Income and Financial Modeling
Businesses use net income in financial modeling to predict their future performance based onpast performance. Financial modeling canbe used to forecast revenue, expenses and cash flow, helping businesses make budgetingdecisions about capital investments, staffing and other resource requirements.
Types of Net Income
The term net income can also be used in personal finance to describe an individual’searnings after deductions and taxes. You may encounter the term net operating income, whichis used in real estate investing. Net operating income reflects the pre-tax profit ofincome-generating real estate investments.
Types of Profit
Net income is one of several important measures of business profitability. Others includegross income and operating income. All measures of profitability rely on accurate andup-to-date data.
Net Income vs Gross Income
While net income reflects profit after subtracting all expenses, gross income measures profitafter subtracting only the costs of manufacturing or acquiring products for resale and/ordelivering services to customers. Product-based companies can calculate this by subtractingthe COGS from total sales revenue. These are the direct costs associated with making oracquiring goods, and include expenses like raw materials, manufacturing or warehouse labor,inbound shipping and the cost to operate production equipment.
Grossincome = Sales revenue - COGS
What Is Operating Income?
Operating income measures a business’s income from core operations. It’s calculated by subtracting operating costs from grossincome. These costs include the salaries of sales and administration personnel,investments in marketing, office space and other expenses required to run the business thatare not included in COGS. Operating income excludes non-operating expenses, such as capitalexpenditures, interest payments and taxes.
Net Income and Business Taxes
Net income is the profit remaining after all expenses, including business taxes—which is whyit’s also sometimes referred to as net income after taxes (NIAT). A company’s incomestatement will also show its net income before taxes, which can be helpful when comparingbusinesses in states that have different tax rates.
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Net Income vs Cash Flow
While net income reflects the accounting profit that a business makes during a specificperiod, cash flow reflects the amount ofmoney that actually comes in or goes out. Positive cash flow means the business can payroutine expenses and meet short-term financial obligations.
It’s possible for a company to be profitable yet still have negative cash flow—and viceversa. Companies that use the accrual accountingmethod recognize revenue when it is earned and expenses when they are incurred, notwhen money actually changes hands. So, if a company earns a lot of sales revenue during oneperiod but doesn’t get paid until after the end of the period, it could show a profit forthe period but still experience negative cash flow.
Net income is the first line in the company’s cash flowstatement. Non-cash accrued expenses, such as depreciation, that were subtractedwhencalculating net income are added back into the cash flow statement to provide a picture of acompany’s actual cash position rather than its profitability.
Net Income (NI) Formula
Net income is calculated by subtracting all expenses from total revenue/sales:
Netincome = Total revenue - total expenses
How to Calculate Net Income (NI)
To calculate net income, start with sales revenue. Deduct COGS, operating expenses,non-operating expenses and taxes. Add any non-sales income, such as interest on investments.
Here’s a closer look at how net income is calculated:
Calculating Net Income |
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Sales or revenue |
Here are the steps in more detail:
- First, calculate gross income by finding revenue from sales and subtracting the COGS.Revenue represents the amount the company earned for its products or services. COGSincludes any costs associated with directly creating the product or service.
- Calculate operating expensesand subtract them from gross income to obtain operating income. Examples of operatingexpenses are administrative costs such as salaries of staff not involved in makingproducts, rent, utilities, research, marketing, depreciation and amortization ofcapital.
- Deduct non-operating expenses, which are expenses not related to product production oroperations. A typical non-operating expense is interest paid.
- Add any non-operating income. This is any income derived from sources other than fromproducts or services. Examples include dividends or interest paid to the company.
- Subtract taxes to obtain net income.
Examples of Net Income for Businesses
Here’s an example of a net income calculation for ABYZ Candy Co. This small business hadsales of $75,000 during the quarter. The cost of manufacturing the candy during the periodwas $39,500, leaving a gross income of $35,500. The company’s operating expenses came to$12,500, resulting in operating income of $23,000. Then ABYZ subtracted $1,500 in interestexpense and added $1,700 in interest income, yielding a net income before taxes of $23,200.Once federal, state, and local taxes of $7,500 were subtracted, ABYZ Candy was left with anet income of $15,700.
Calculating Net Income | The ABYZ Candy Inc. | |||
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Sales or revenue | $75,000 | |||
Free Net Income Template
Calculate your business’s net income with our free net income template. Download the template.
Net income is a critical profitability metric. It reflects whether a business has made moneyafter all expenses are deducted from total revenue. Businesses can distribute the profits toowners or shareholders or invest in new technologies or growth opportunities—like financial and accountingsoftware to help you track and calculate your net income. Demonstrating the abilityto generate strong net income can help businesses more easily secure bank loans andinvestments.
