Knowing the net income (NI) of your business is important since it’s a straightforward measure of your company’s profitability.1 Specifically, it’s important to calculate net income for a company that sells goods or services. A positive NI indicates a successful business (“in the black”), whereas a negative NI means that your expenses are greater than your profits (“in the red”). These expressions are part of accounting history, and they refer to a company’s current financial state.2
In this article, we’ll break down the net income formula and explain how to calculate net income for your organization.
What Does Net Income Mean?
Net income (NI) is the amount of money your business has earned—after expenses, cost of goods (or services) sold, taxes and interest—during a specified time period. Another name for this key business metric is net earnings.1 Smaller companies often don’t bother to calculate their NI until asked to do so by a potential investor or a lender. However, it is a smart business practice for a company of any size to keep track of this number as an indication of your company’s overall health.
How to Calculate Net Income
The net income formula for a business is, in basic terms, the value of all sales minus the cost of all expenses. However, there are many types of expenses that eat into a company’s sales profits. This includes everything from daily administrative costs and COGS (cost of goods sold) to interest on loans, equipment depreciation, and amortization.3,4,5,6 Knowing how to calculate net income for your company lets you see the bigger picture for more savvy financial planning.
When calculating your company’s expenses, you should be sure to include all operating costs, such as:7
- Payroll and Employee Benefits
- Leasing of Office Space
- Costs of Goods Sold
- Sales Commissions
The net income formula is:
Net Income = [Total Sales] – [COGS] – [Operating Expenses] – [Non-Operating Expenses] + [Non-Operating Income] – [Taxes]
In this simplified net income example, imagine a retail donut shop that sold $60,000 in coffee and donuts for the first quarter of the year.
- You begin with $60,000 in total sales.
- The COGS to produce the baked goods and beverages during that time was $29,500.
- Subtracting the COGS from the total sales gives you $30,500 in gross income.
- The donut shop had operating expenses in those first three months of $7,750.
- Gross income minus the $7,750 leaves $22,750 in operating income.
- There may also be non-operating expenses (i.e., costs from currency exchanges, interest payments on loans) and non-operating income (i.e., sale of assets, dividend income), which would also need to be subtracted and/or added from the operating income.8,9 In the case of our simple donut shop, there are no such expenses or income. Therefore, the net income before federal, state, and local taxes is $22,750.
- The donut shop paid $6,250 in taxes for that quarter. These taxes are subtracted from the net income.
- Using the full net income formula, we can confidently say that the total net income for our donut shop is $16,500.
It’s important to note that this is an extremely simplified example; small businesses will likely have many more expenses than our imaginary donut shop. But although it’s scaled down, it helps to highlight how net income is very different from the total number of sales, which can sometimes be a misleading number.
Is There a Difference Between Net Income and Operation Net Income?
In addition to net income and net operating income (operation net income), there is also operating income. These three stages of business income can be confusing, so we’ll walk you through how they differ:
Operating Income is a company’s income after subtracting operating expenses. This doesn’t just include the cost of doing business, such as salaries, rent, advertising and marketing, insurance and office supplies. It also includes the direct cost of goods, like the cost of inventory or materials for manufacture.10 It also includes depreciation and amortization of assets.11
To obtain the Net Income, you must subtract all business expenses, which include non-operating expenses such as the company’s taxes and interest paid on a business loan.11
Net Operating Income is a measure of an income-producing property’s profitability. This term is most often used in real estate, but it is used by any business that receives income from a property.12
The formula is:
Net Operating Income = [All Revenue from Property (rent, parking, laundry, vending machines)] – [All Related Operational Costs (maintenance, staff payroll, utilities, insurance, repairs)]
In this example, a building owner leases out office space to an organization. This space includes four offices, a conference room, a kitchenette, and on-site parking.
- The property revenue for the first quarter is $15,000, which includes monthly rent as well as a cleaning service and landscaping/building maintenance.
- The owner’s related operational costs are as follows: $6,000 for the cleaning crew and building maintenance, $2,500 for utilities (heating and electricity provided), and $1,500 for insurance. This adds up to total operational costs of $10,000.
- The building owner’s net operating income is $15,000 minus $10,000, which equals $5,000.
Who Looks at Net Income?
Whether you’re a business owner, private investor, stakeholder, lender, or auditor, if you know how to use the net income formula for a company, you can get the complete financial picture for that business.13 Knowing an organization’s net income is very important, as it gives you the insight you need to make smart business decisions. Here’s how its impact breaks down by category:
- Individual – Indicates your take-home pay after taxes so that you can better plan your personal budget.13
- Business Owner or Chief Financial Officer – Provides insight into how profitable your company really is, as well as which business expenses you may be able to cut back on, such as travel costs, marketing expenses and legal fees.13
- Investor - Helps you to determine the true value of a company’s stock, so that you can decide if it’s worth investing in.13
- Lender – Before a bank agrees to give a company a loan, they will look at company finances (such as its net income and balance sheet) to get a better understanding of its assets and liabilities, to determine if the person borrowing will be able to pay off the loan.14
- Auditors – When a company is being audited, net income is one of the benchmarks used to determine the “threshold level of materiality”15.
In each case, net income is used to assess a person or company’s financial health to make more confident business decisions.
Translate Financial Knowledge Into Action
Now that you understand how essential net income is for financial planning at every level, you can see how valuable skills like this are to help businesses manage their finances. In today’s job market, employers are especially looking for individuals with higher-level experience and education to lead their financial strategies. If you’re an accounting professional who wants to capitalize on those opportunities, explore the possibilities of a cutting-edge degree like the Online Master of Science in Accounting from Yeshiva University.
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2. Retrieved on November 26, 2021, from investopedia.com/terms/n/netincome.asp
3. Retrieved on November 26, 2021, from investopedia.com/terms/c/cogs.asp
4. Retrieved on November 26, 2021, from investopedia.com/terms/i/interestexpense.asp
5. Retrieved on November 26, 2021, from investopedia.com/terms/d/depreciation.asp
6. Retrieved on November 26, 2021, from investopedia.com/terms/a/amortization.asp
7. Retrieved on November 26, 2021, from quickbooks.intuit.com/r/expenses/8-ways-reduce-operating-costs/
8. Retrieved on November 26, 2021, from investopedia.com/terms/n/non-operating-expense.asp
9. Retrieved on November 26, 2021, from wikiaccounting.com/non-operating-income/
10. Retrieved on November 26, 2021, from smallbusiness.chron.com/income-operations-same-thing-operating-income-80026.html
11. Retrieved on November 26, 2021, from investopedia.com/ask/answers/122414/what-difference-between-operating-income-and-net-income.asp
12. Retrieved on November 26, 2021, from indeed.com/career-advice/career-development/operating-net-income
13. Retrieved on November 26, 2021, from smartasset.com/taxes/net-income
14. Retrieved on November 26, 2021, from sba.gov/blog/5-things-know-about-your-balance-sheet
15. Retrieved on November 26, 2021, from materialitytracker.net/standards/financial-thresholds/