Understanding the financial health of your business is vital. And there are multiple important metrics you should track that can offer valuable insight. But perhaps the most important is net income, which indicates whether your company has made a profit. But it’s more 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 of an income statement, reflects whether a business has made a profit after all expenses are deducted from total revenue. It’s profit that can be distributed to business owners or invested in business growth. Investors and banks use net income to help decide whether a company is worthy of investment or a loan. Publicly traded companies use it to calculate earnings per share and distribution of dividends.
- Net income, also known as the bottom line, indicates a business’s profitability. It shows how much profit is left from revenue after accounting for expenses and liabilities.
- Net income is profit that can be distributed to business owners or shareholders or invested in business growth.
- Investors and banks consider net income when deciding whether to invest in or lend money 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 expenses over a specified period, such as a fiscal year or quarter. These expenses include the cost of producing goods, operating expenses, non-operating expenses and taxes—all of which are subtracted from a company’s total revenue to arrive at net income.
Some small businesses start tracking expenses and revenue with a simple spreadsheet—but even small businesses and startups can benefit from business accounting software.
Other Names for Net Income
Net income is also referred to as net profit, net earnings, net income after taxes (NIAT) and the bottom line—because it appears at the bottom of the income statement. A negative net income—when expenses exceed revenue—is called a net loss.
Net income and net profit are often used interchangeably. However, profit refers to what that remains after expenses and can be used in other calculations. For example, gross profit is revenue minus the cost of goods sold (COGS). So be sure to pay attention to the type of profit referenced (net profit, gross profit, etc.) to make sure that you’re using net profit as the correct synonym for net income.
Another way to reference net income. Earnings are your company’s profits after expenses and liabilities, including taxes.
Importance of Net Income for Businesses
Net income is also used to calculate other metrics such as net profit margin and operating cash flow. Banks consider net income when approving a business loan application, as do investors when deciding whether to invest in a company. Companies use net income to calculate earnings per share (EPS), a widely used profitability metric, to report to shareholders, VCs and other investors.
Net income is also used to calculate net profit margin, which is net income expressed as a percentage of revenue. This shows how much of revenue is converted to actual profit after expenses are paid. More efficient companies have higher percentages or margins. But this will vary by industry.
Business accounting software makes it easier for you to generate reports and get access to real-time data. And managerial accounting practices can take that data a step further. Make better and more strategic business decisions 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 on past performance. Financial modeling can be used to forecast revenue, expenses and cash flow, helping businesses make budgeting decisions 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’s earnings after deductions and taxes. You may encounter the term net operating income, which is used in real estate investing. Net operating income reflects the pre-tax profit of income-generating real estate investments.
Types of Profit
Net income is one of several important measures of business profitability. Others include gross income and operating income. All measures of profitability rely on accurate and up-to-date data.
Net Income vs Gross Income
While net income reflects profit after subtracting all expenses, gross income measures profit after subtracting only the costs of manufacturing or acquiring products for resale and/or delivering services to customers. Product-based companies can calculate this by subtracting the COGS from total sales revenue. These are the direct costs associated with making or acquiring goods, and include expenses like raw materials, manufacturing or warehouse labor, inbound shipping and the cost to operate production equipment.
Gross income = 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 gross income. These costs include the salaries of sales and administration personnel, investments in marketing, office space and other expenses required to run the business that are not included in COGS. Operating income excludes non-operating expenses, such as capital expenditures, interest payments and taxes.
Net Income and Business Taxes
Net income is the profit remaining after all expenses, including business taxes—which is why it’s also sometimes referred to as net income after taxes (NIAT). A company’s income statement will also show its net income before taxes, which can be helpful when comparing businesses in states that have different tax rates.
Net Income vs Cash Flow
While net income reflects the accounting profit that a business makes during a specific period, cash flow reflects the amount of money that actually comes in or goes out. Positive cash flow means the business can pay routine expenses and meet short-term financial obligations.
It’s possible for a company to be profitable yet still have negative cash flow—and vice versa. Companies that use the accrual accounting method recognize revenue when it is earned and expenses when they are incurred, not when money actually changes hands. So, if a company earns a lot of sales revenue during one period but doesn’t get paid until after the end of the period, it could show a profit for the period but still experience negative cash flow.
Net income is the first line in the company’s cash flow statement. Non-cash accrued expenses, such as depreciation, that were subtracted when calculating net income are added back into the cash flow statement to provide a picture of a company’s actual cash position rather than its profitability.
Net Income (NI) Formula
Net income is calculated by subtracting all expenses from total revenue/sales:
Net income = 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:
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. COGS includes any costs associated with directly creating the product or service.
- Calculate operating expenses and subtract them from gross income to obtain operating income. Examples of operating expenses are administrative costs such as salaries of staff not involved in making products, rent, utilities, research, marketing, depreciation and amortization of capital.
- Deduct non-operating expenses, which are expenses not related to product production or operations. A typical non-operating expense is interest paid.
- Add any non-operating income. This is any income derived from sources other than from products 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 had sales of $75,000 during the quarter. The cost of manufacturing the candy during the period was $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 interest expense 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 a net income of $15,700.
Calculating Net Income
The ABYZ Candy Inc.
Sales or revenue
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 money after all expenses are deducted from total revenue. Businesses can distribute the profits to owners or shareholders or invest in new technologies or growth opportunities—like financial and accounting software to help you track and calculate your net income. Demonstrating the ability to generate strong net income can help businesses more easily secure bank loans and investments.