Net income: uses, formula, and how to calculate

KEY TAKEAWAYS:

• Net Income = Gross Income – Total Expenses
• It is the amount of money your business makes after deducting cost of goods sold (including returns & allowances), operating expenses, and taxes.
• Often called “the bottom line” because it is found on the last line of your company’s income statement.

As a small business owner, generating profit is a top priority. But it’s important to understand that the revenue you earn won’t always tell you the whole story. You need other information to get an accurate picture of how your business is doing. Net income is one piece of data that will help you understand your business’ health. It is a good indicator of your company’s profitability. Taking the time to learn how to calculate net income is crucial.

What is net income?

Net income (NI), sometimes called net earnings, refers to the amount of money a business makes over a given period of time after deducting costs, allowances, and taxes. Along with revenue and other key financial figures, NI is regarded as an important number in accounting.

Net income is typically found on the last line of your company’s income statement, which is why it’s also sometimes called “the bottom line.”

Why is net income important for small businesses?

Net income is a key metric for small businesses and small business owners to understand. NI gives insight into your small business’s profitability and thus is extremely useful to know. For small business owners, keeping track of this metric might seem daunting at first. It may even be something you wait to do until asked by a lender or investor. But keeping track of your NI is a great way to monitor the financial health of your business.

Speaking of lenders and investors – having your NI calculations available to them is important. Before handing over any funds, they need to make sure you and your company are in a stable financial position. Lenders and investors often want to confirm you have enough money to pay back debts. They may also be interested in how much money your business has available for dividends, reinvestment, emergency funds, etc.

How to calculate net income

To calculate net income for your business, start with the gross income. Gross income is the total revenue generated by the business after subtracting cost of goods sold (COGS).

Gross Income = Total Revenue – Cost of Goods Sold

Then, subtract other expenses (rent, utilities, taxes, etc.) from the gross income to find NI. If you’re wondering, taxes in this case includes things like excise taxes, payroll taxes, and property taxes. It does not refer to business income taxes. So, the formula for net income is:

Net Income = Gross Income – Other Expenses

You can also calculate the net profit margin by dividing your net income by revenue and multiplying it by 100 to get a percentage. This percentage will show how much money you bring in from each dollar of revenue. Read more about this topic in this article all about profit margin calculation.

When your business revenue outweighs expenses, you’ll have a positive net income. On the other hand, if your total expenses are greater than your revenue, you’ll have a negative net income – a net loss.

A small business calculation example

Want to see the formulas above in action? Refer to the example below, which breaks down how net income is calculated for a small business.

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Sweet Treats Bakery net income calculation

Let’s look at the fictional company “Sweet Treats Bakery”. The company’s accountant wants to know how the bakery is doing in the first quarter (Q1). Sweet Treats’ income statement shows the following information:

• Total Sales Revenue: $100,000
• Cost of Goods Sold (COGS): $30,000
• Operating Expenses: $20,000
• Interest Expense: $2,000
• Taxes: $8,000

First, the accountant begins by calculating gross income:

Gross Income = Total Revenue – Cost of Goods Sold

$100,000 – $30,000 = $70,000

Sweet Treats’ gross income is $70,000 for Q1.

Next, the accountant will add up the other business expenses:

Total Expenses = Operating Expenses + Interest Expense + Taxes + Other Expenses

$20,000 + $2,000 + $8,000 = $30,000

Sweet Treats’ total other expenses are $30,000 for Q1.

Finally, to calculate NI, the accountant subtracts total expenses from gross income:

Net Income = Gross Income – Total Expenses

$70,000 – $30,000 = $40,000

Sweet Treats’ NI is $40,000 for Q1.

Remember that this is a simplified example. Actual calculations may involve more complex factors and additional deductions. It all depends on the business in question and its specific expenses.

Calculating NI: the bottom line

Net income gives important insight into a business’s profitability. By using the net income formula, you have a better understanding of where your company stands financially. Even if your business shows significant revenue at the end of a quarter, your financial overview won’t be complete until you factor in all expenses and business spending to calculate net income.

If you need help keeping track of NI and other important metrics, Block Advisors has your back. You can save time and money with our bookkeeping services.

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