How to calculate net income (formula with examples)

Net income is the final tally of your earnings after you’ve taken care of all your expenses and taxes. It’s like the prize at the end of a financial puzzle, representing what you actually get to keep and use for your business. For small business owners, understanding net income is crucial as it helps you measure the true profitability of your business.

Net income, also known as profit, is the bottom line that reflects your company’s financial performance for a particular period. It’s the reward for all the hard work, innovation, and strategic decision-making that goes into running a business. 

Like the final score in a game, net income tells us whether a company is winning or losing in the competitive market.

And speaking of winning and losing, have you ever wondered why people say a business is “in the red” or “in the black“? 

Well, back in the day, when accounting was done by hand, accountants used red ink to record losses and black ink for profits. This was a simple yet effective way to represent a company’s financial status visually. 

So when someone says a business is “in the red”, it means they’re operating at a loss, while being “in the black” signifies profitability. It’s a vivid reminder of the history behind financial jargon^[1]!

Now that we have a slight understanding of what net income represents, let’s explore the subject further.

Net income and financial analysis 

Understanding net income is super essential for analyzing your business’s financial health. Even though many small businesses don’t think about how much money they’re making until a lender or investor asks, keeping an eye on your net income can help you see how well your business is doing.

If your net income is going up, that’s a good sign! It means your business is probably doing things right. But if it’s not going up, it might be time to find ways to spend less money.

Net income is also a big deal for lenders and investors. Lenders want to know if your business will have enough money to pay back what it owes them, and investors want to know if it will have extra money left over to pay dividends, invest back into the business, or save for tough times.

So, learning how to calculate net income using the net income formula is a smart move for keeping your business on track financially.

Tip: When analyzing your company’s financials, consider benchmarking your net income against industry averages. This comparison can provide valuable insights into how your business stacks up against competitors and highlight areas for potential improvement.

Let’s calculate net income

Calculating net income is like figuring out how much money your company really made after paying all its bills. It’s what’s left over for important details like paying shareholders, investing in new projects, clearing debts, or saving up.

To get your net income, you start with your revenue^[2] (the money your business brings in), then subtract the cost of goods sold (basically, what it costs to make or buy the stuff you sell), and finally, subtract all your other expenses.

What you’re left with is your net income.

Here’s the formula:

Net Income = Revenue – Cost of Goods Sold – Expenses

You can make it even simpler: your revenue minus the cost of goods sold is called your gross income. 

So you could also say:

Net Income = Gross Income – Expenses

Or, to really keep it basic:

Net Income = Total Revenues – Total Expenses

Now, your net income can be either positive or negative. If your revenue is more than your expenses, you’ve got a positive net income. But if your expenses outweigh your revenue, you end up with a negative net income, also called a net loss.

With this formula, you can determine your company’s net income for any time period—whether it’s annually, quarterly, or monthly—whatever best suits your business.

Let’s crack it down with an example:

Let’s say Olivia runs a bookstore and wants to calculate her net income for the last quarter of 2023.

Here are Olivia’s numbers:

Total revenues: $80,000
Cost of goods sold (COGS): $25,000
Rent: $8,000
Utilities: $1,500
Payroll: $15,000
Advertising: $2,500
Interest expense: $800

First, Olivia calculates her gross income:

Gross income=$80,000−$25,000=$55,000

Next, she adds up her expenses for the quarter:

Expenses=$8,000+$1,500+$15,000+$2,500+$800=$27,800

Now, Olivia can calculate her net income:

Net income=$55,000−$27,800=$27,200

Olivia’s net income for the quarter is $27,200.

Net income vs. gross income: is there a difference?

Understanding the difference between net income and gross income is key. Gross income, also known as gross earnings or gross profits, is what you get when you subtract the cost of goods sold (COGS) from your revenues. COGS are the direct expenses tied to making your products or delivering your services.

Here’s the equation:

Gross income = Revenue – Cost of Goods Sold (COGS)

Usually, you’ll spot your COGS right near the top of your income statement, just after your revenues.

COGS can cover things like:

• Raw materials
• Labor
• Packaging, shipping, and freight
• Energy and utilities for production
• Depreciation on production equipment

But remember, COGS doesn’t include indirect expenses^[3], also known as overhead or operating costs. These are expenses like salaries for management, administrative costs, utilities, insurance, and interest. They’re not directly tied to producing goods or services.

Net income and operating income

Understanding the connection between net income and operating income helps understand a company’s profitability from different angles. While gross income focuses solely on subtracting the cost of goods sold (COGS) from revenues, operating income takes things a step further by incorporating operating expenses.

Operating expenses, also known as Selling, General, and Administrative (SG&A) expenses^[4], encompass costs that aren’t directly tied to production. These can include expenses like marketing, administrative salaries, and office rent.

Here’s the equation for operating income:

Operating Income = Gross Income – Operating Expenses

So, to calculate operating income, you subtract operating expenses from gross income.

If you write down all three formulas, you’ll see how gross profit, operating income, and net income show different levels of profitability caution as time goes on.

1. Gross profit: Revenues – COG
2. Operating income: Revenues – COGS – Operating expenses
3. Net income: Revenues – COGS – Operating expenses – Non-operating expenses

Net income, being the most conservative measure, accounts for all major expense types: COGS, operating, and non-operating expenses. This comprehensive approach provides a clearer picture of a company’s overall profitability over a given accounting period.

How to calculate operating income

Operating income is a handy figure to keep tabs on because it focuses solely on a company’s profits from its main operations without muddling the picture with unrelated income and expenses. 

This means it doesn’t include taxes, interest expenses, or gains or losses from selling assets that are not directly related to the core business.

You might also hear it called EBIT, which stands for earnings before interest and taxes^[5].

The formula for operating income is pretty straightforward:

Operating Income = Net Income + Interest Expense + Taxes

Or, you can think of it like this:

Operating Income = Gross Profit – Operating Expenses – Depreciation – Amortization

Investors and lenders often prefer to look at operating income because it gives them a clearer view of how profitable the company’s main activities really are.

For example, let’s say a company’s main business is struggling, but they make a big profit from selling a building. That profit would boost their overall net income, making it look like they’re doing better than they really are. Operating income strips away those kinds of one-off gains, giving a more accurate picture of the company’s true performance.

You can find this kind of information in a cash flow statement, which is a really helpful tool for understanding how healthy a company is.

Remember Olivia’s numbers from the above section? Let’s use the same example to calculate Olivia’s operating income for the last quarter of 2023 for her bookstore.

Given:
Net income: $27,200
Interest expense: $800

Operating income can be calculated by adding back the interest expense to the net income:

Operating Income=Net Income+Interest Expense

Operating Income=$27,200+$800

Operating Income=$28,000

So, Olivia’s operating income for the last quarter of 2023 is $28,000.

The bottom line

Understanding net income is essential for small business owners who want to make informed financial decisions by measuring profitability and getting insights into their financial health. However, managing your finances involves more than just understanding net income—it requires comprehensive financial planning and analysis.

CoCountant offers tailored financial services to help you maintain a clear and accurate picture of your business finances. From detailed daily bookkeeping to strategic financial planning and compliance, we ensure your financial data is not only accurate but also actionable. 

With us, you can focus on growing your business while we handle the complexities of financial management.

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