What Is Net Income Formula and How to Use It

Net income is one key metric that you can use to assess your business’ financial health. You can calculate it by using a net income formula. In accounting, net income is the total amount of cash you have after deducting expenses, but it’s a little more complicated than that.?

What is Net Income?

For an individual, net income is sometimes called “take-home pay”. It’s the amount of money that you earn after taxes, insurance, and other expenses are deducted from your total pay or gross income.?

Similarly, the net income for a business is the amount of money after deducting all business expenses, including wages, interest, operation costs, and taxes. Net income, also known as the bottom line, net earnings, or net profit, appears at the bottom of income statements.??

Generally, a healthy, growing business will have net incomes that exceed total expenditures. In other words, the more profit and fewer expenses you have, the healthier your business.

If you run a publicly-traded company, you’ll also have to consider?retained earnings . For public companies, retained earnings is the amount of net income left after paying shareholder dividends and earnings per share. If you are a small business without investors, you may not have to worry about accounting for retained earnings.?

How Do You Calculate Net Income?

The net income formula helps calculate the net income of either an individual or a business.?

For individuals, calculating net income is fairly straightforward. You take the total amount of cash earned over some time (gross income) and then deduct all expenses, such as interest payments and taxes.?

Net Income Formula

Businesses can use the net income formula to calculate net income for any timeframe. There are two primary ways to calculate net income–using revenue and expenses or gross profit and expenses. We’ll go over each net income formula and how to use them.?

Total Revenue?

A simple method of calculating net income takes your total revenue and subtracts all expenses.?

• Total Revenue – Total Expenses = Net Income

However, you’ll also want to account for operating and non-operating expenses. For example, the cost of goods sold is an operating expense. In this case, you may want to use gross profit in your calculation.?

Total Gross Profit

You can do this one of two ways:?

• Revenue – Costs of Goods Sold – Expenses = Net Income

Revenue minus the cost of goods sold is the formula for calculating gross profit. So, the first part of the formula is calculating that already. Another way of writing the formula is:?

• Gross Profit – Expenses = Net Income

When using the formula, you might get a positive or a negative result. A positive figure means you are generating more income than expenses, while a negative figure means you’re spending more than you make.?

It’s also important to note that net income may include revenue that does not come from your core business activities. For example, if your business owns real estate and rents out part of it, or you gain royalties from a past partnership. This is generally referred to as non-operating income.?

Individual Net Income Example

For individual net income, let’s consider Nancy, an employee at a local ski shop. Nancy receives her paycheck every two weeks with gross pay of $4,500. She also receives $200 in interest and $600 in equity as her other forms of income.??

She then pays all her taxes including:?

• Social Security taxes ($279)
• Federal taxes ($450)
• State taxes ($163.91)
• Medicare taxes ($65.25)
• Insurance ($280)?

Usually, these are automatically taken out of your paycheck. After all these deductions, Nancy is left with a net income of $4,061. Here are the exact steps to calculate it.?

• Gross income – total expenses = net income?

For Nancy, the math would like like this:?

• $4,500 (Gross Pay) + $200 (Interest) + $600 (Equity) – $279 (Social Security Tax) – $450 (Federal Tax) – $65.25 (Medicare Tax) – $163.91 (State Tax) – $280 (Insurance) = $4,061 (Net Income)??

Because Nancy’s gross income includes equity and interest, it totals to $5,300. Based on her biweekly paycheck, Nancy takes home an annual net income of $105,586.?

Business Net Income Example

To fully understand the net income formula, let’s look at a hypothetical business scenario.?

Marcus’ Archery, a company specializing in manufacturing and selling archery equipment, wants to calculate its net income for the fourth quarter. Here are the necessary figures to calculate net income from its accounts:?

• Total Revenues: $20,000,000
• Costs of goods sold (COGS): $8,750,000
• Rent: $150,000
• Utilities: $40,000
• Payroll: $250,000
• Advertising: $70,000
• Interest expense: $70,000

According to the net income formula, Marcus’ Archery first needs to calculate gross income. You would do this by subtracting the costs of goods sold, including direct labor costs, from the total revenue.?

• $20,000,000 (Total Revenues) – $8,750,000 (COGS) =?$11,250,000 (Gross Income)

The next step is to add all expenses for the fourth quarter.

• $150,000 (Rent) + $40,000 (Utilities) + $250,000 (Payroll) + $70,000 (Advertising) + $70,000 (Interest Expense) =?$580,000 (Total Expenses)

With all these results, Marcus’ Archery can now calculate its net income. To do this, you use the net income formula and subtract total expenses from gross income.

• $11,250,000 (Gross Income) – $580,000 (Total Expenses) =?$10,670,000 (Net Income)

Overall, the fourth quarter’s net income for Marcus’ Archery is $10,670,000.

These are simplified explanations of how to calculate net income. Depending on factors like whether or not you have business loans, employee equity, or investors, it can get much more complicated. In this case, you’d want to also calculate operating income, which is different from net income.?

How Xendoo Can Help

Net income is a critical metric for any individual or business’s financial health. The monthly income statement report details how money circulates inside and outside the business. At Xendoo, generating up-to-date net income reports is one of the many bookkeeping and tax services you can access from our organization.?

With Xendoo, you get a team of real people and bookkeepers who dedicate their skills and expertise to the success of your business or individual finances. Additionally, we integrate our services with the best software to ensure all your accounts are accurate.?Get started today ?to meet your dedicated CPA team and expert bookkeeper.?