What is Net Income?
For businesses, net income indicates how well a company is managing its profit (both earnings and expenses). For individuals, this number is defined more loosely: it can refer to your gross income net of expenses, or your take-home pay.
Net Income for Businesses
Net income for a business represents the income remaining after subtracting the following from a company's total revenue:
All operating expenses
Cost of Goods Sold
Net income for a business is found on the income statement.
This number is examined by shareholders, prospective investors, and potential lenders to help determine if the company is solvent and able to pay additional debts.
Net Income for Individuals
For cash flow purposes, net income is the equivalent of net pay: the total amount you have earned in a pay period, minus the following deductions and taxes:
Social Security taxes
Medicare and Medicaid taxes
All deductions may not apply to you and that tax obligations may differ. For example, your company may not provide a retirement contribution plan. Also note that net income can fluctuate from a tax perspective depending on which type of retirement plan you contribute to.
Gross Income vs. Net Income
A company or individual’s net income will always be a smaller amount than its gross income (the income before taxes or adjustments).
Gross Income vs. Net Income for Business
Net income shows a company's income after all expenses. Gross profit shows a company's revenue minus the costs of sales/costs of goods sold; it is the income left, after product costs, to cover all other expenses.
For example, a car manufacturer sells $1,000,000 worth of cars to dealerships. It costs $600,000 to build the cars (direct cost of sales). The manufacturer's gross profit would therefore be $400,000.
Gross profit is located near the top of the income statement. It does not include all the company's fixed operating costs, Such as salaries, rent, amortization, deprecation, and other expenses that extend down the income statement (and are all included in the company's net income).
Gross Income vs. Net Income for an Individual
Gross income for an individual is the total amount earned for a period of time before payroll deductions. Net income is simply your net pay, usually the amount deposited into your own checking account.
When filing your US taxes, you will report your gross income (total income) using a Form 1040.
Net income is not a tax term, so you will not actually find it on your Form 1040. Instead, the Individual Income Tax Return determines an individual's adjusted gross income and taxable income. If you want to know your net income using a past tax return, use the following calculation:
The Net Income Formula
You can calculate net income for a business by using the following formula:
Net income is found on the last line of the income statement, which is why it’s often referred to as “the bottom line”. Depending on where you’re located (like the UK), you may also hear net income referred to as net profit or net earnings.
To calculate an individual’s net income, use the following formula based on a recent pay stub.
Types of Net Income and Examples
Net income shows an individual’s or company’s financial position. When examining a company’s (or your own) finances, you can use net income in a variety of ways.
Two common types of net income examples include:
Annual Net Income Calculated for a Business
A common way to use net income is by looking at it annually. Annual net income over multiple years can be examined for growth. Quarterly net income is scrutinized as public companies release quarterly earnings reports, with net income at the bottom of the income statement.
Let's look at a hypothetical income statement for Company Y and calculate the annual net income:
Company XYZ's Annual Income Statement
To find net income using this formula, start with the firm's revenue then subtract all the expenses (e.g. salaries, rent, amortization, depreciation, interest expense, tax).
By using the formula we can see that:
Net Income = $2,000,000 - ($1,000,000 + $500,000 + $25,000 + $75,000 + $50,000 + $100,000) = $250,000
After taking the company's $2 million in revenue – and subtracting the $1,750,000 in total expenses it had over the year – Company Y was left with a net income of $250,000.
Operating Income vs Net Income
Operating income is found by only accounting for certain expenses, while net income accounts for all expenses. They both represent income earned by a company, but give insight into the way money is managed at different points in operation.
Net operating income = Revenue - Operating expenses- Depreciation- Amortization
The net operating income doesn’t account for company debt (interests paid) as net income does. It’s definitely possible to have a profitable business but have debt wipe out that profit and show a negative net income.
Net Income Frequently Asked Questions (FAQs):
What does negative net income mean?
When you see a negative net income on a company's income statement, it means that the company's expenses added up to more than its revenue. Thus the organization suffered a "net loss" over that period.
Generally, when a company's net income is low or negative, a myriad of problems could be to blame. These can range from decreasing sales to poor customer experience to inadequate expense management.
If a company has high net income, does it also have a positive cash flow?
Not necessarily. It's important to know that net income is not a measure of how much cash a company earned during a given period. Remember: The income statement includes a lot of non-cash expenses (such as depreciation and amortization).
To learn about how much cash a company generates, you need to examine the cash flow statement.
What's the best way to compare net income between companies?
Net income varies greatly between companies and industries. It is often more appropriate to consider net income as a percentage of sales (known as a profit margin).
Net income also plays a key role for investors when they compare company earnings using the price-to-earnings (P/E) ratio. This ratio states how much the investor is paying (the stock price) for each dollar of net income that the company is able to generate.
Dive Deeper into Net Income with InvestingAnswers
Need more answers on net income? Check out these definitions and articles from InvestingAnswers:
8 Key Facts to Know About a Company Before You Invest -- See how net income and other key terms can tell you whether or not to invest in a company.
Financial Statement Analysis: The Income Statement -- Learn the most important components of the income statement and how to use them to determine a company's profitability.
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